Should I Invest in Small Town America?

Is investing your money in small town America a good investment?  This is a good question to ask and I would like to take the time to share the pros and cons with you today.  Being a broker in small town America, I probably have better insight than brokers who are from large metropolitan districts.  It is easier to see opportunities and also realize the pitfalls.  As in any real estate investment, especially a commercial cash flow investment… location, location, location is key!  If you choose a small town, it is probably best to consider national tenants who have a long history of stability in a community.  For example, good picks are Dollar General, Family Dollar, CVS, Walgreens and the like.  Usually, these retailers choose these towns because they have calculated the long term risk for the next twenty years and have chose to make their investment upon calculated risk. So, realizing these retailers do not blindly enter these markets without a certain amount of research, these opportunities make for the best investments.

The next consideration is to consider the stability of the local employment, where does everyone work, shop, play, educate themselves and live?  If it happens to be in the same community add another positive checkmark to the list.  Next step is to consider the actual location in the town, is the site located at Main & Main, or is it off the beaten path?  Is there room to grow?  Does the current site meet the most up-to-date store criteria for the retailer…e.g. store size, parking, visibility, accessibility and the like?  As always, you have to consider any deferred maintenance issues for the facility, roof, HVAC, parking lot and the overall integrity of the facility. 

The next step is the lease, of course, the first question normally asked is how many years remain on the lease.  If the building is up-to-date and meets the current size requirement for the retailer, and the retailer has a long history in the same location the risk with a shorter term remaining on the original lease or option period is not as great as another site not meeting the required criteria.  Yes, we would all rather purchase an investment with 10 years life in a lease or 20 would even be better, but many local investors have learned throughout the years, not to worry too much.  I have met many investors who have gone five years at a time for over twenty-five years and realizing the safety of their investment.  I sometimes think especially for out-of-town investors, too much weight is placed upon the initial length of the lease versus weighting out the extensions and when the dates when the extension agreements were executed.

Another great investment is small multi-tenant properties with national and regional tenants or medical offices.  There are some very strong regional tenants which prefer to lease versus own property, and with good lease terms will make for a stable investment.  Also, any medical office where the tenant has spent a significant amount of money in build-out is usually a good bet as well. 

Opportunities where you should be more cautious include: companies in bankruptcy; retailers connecting to changing technologies have a higher risk; intensive management situations: e.g. multi-tenant properties with many local service providers, government offices, ect.; restaurants in some situations; and self-storage.  Self-storage can be very management intensive and finding a good local manager can be tough, government related leases sometimes have clauses where the tenant can exit early out of the lease which is more risk than what some investors are willing to handle. 

Bottomline, when evaluating opportunities in small town America, a great deal of the value proposition is based upon weighing out the risks.  Usually there are fewer zoning laws which can be a double-edged sword;  if demand is not great and the retailer moves, what is the real value of the property?  Is there a retailer to replace the existing one, and what would be the fair market rent?  On the other hand, less zoning if building a project is usually favorable, retailers as mentioned, do not make decisions in haste to move to small towns, and if they have chosen a site, it is normally with good reason and a fair bet they plan to stay for a long while. 

The last point!  Yes, you can always find investments that bring higher returns than others, however a 9% return on investment is not a bad return compared to 6.5%.  The question is… are you okay acknowledging the investment for 9% is only guaranteed for 3-7 years in some cases versus a 6.5% return for twenty years.  And how discriminating is the 20 year tenant versus a tenant who leases for five years at time?  There are many variables to consider, and the length of the lease is only one factor.

There are many great opportunities in small town America and I hope this provides some insight as to how to evaluate investment decisions.  

Real Estate Cycle

There are a lot of great opportunities for investors to consider in real estate now.  Personally, I think it is probably a good idea not to listen to CNBC, CNN or any other newscast for awhile.  We are not going into a double dip recession, we are in the expansion phase of the real estate cycle and understanding this must realize, it is not always easy to snap back into place like a rubber band.  In Phase I, there is very little new construction and vacancy is decreasing.  So looking around the neighborhood, my neighborhood and yours, you will find that retailers and small business is becoming a little more adventurous and vacancy is decreasing.  Rents may not be as robust as we like, however at least there is activity and business professionals are willing to take a certain amount of risks.   In residential real estate, there are no specs under construction; however there is a limited amount of custom work and with jobs this area of the market will eventually improve. 

In South Central Indiana, Cummins Engine has announced many new jobs nearly a thousand between Columbus and Seymour, Honda in Greensburg is hiring a thousand new workers, and companies like Valeo-Sylvania and Schwartz Pharma has also announced new job openings.  So rather than spend all our time glaring at the television allowing our nervous system to develop acute panic, it is time to realize, this is happening throughout our country.

This recession and change in the global economy will also produce a change in the way employers do business.  We have seen changes for a long period of time with increased automation and the need for a more sophisticated workforce.  This is not all that bad and part of growth to make our nation smarter and stronger to compete and grow.  So rather than resist growth, it appears to me, we should embrace it and realize this is part of our evolution as a country, not only economically, but socially.

Good things are happening in America, it should not be all gloom and doom.  If anybody wants to beat anyone up, let’s beat up congress because they do need to reform themselves.  But, no matter how disparaged we may think we are, truthfully compared to many places in the world, we are alright!

Now is a great time to consider the following property types: multi-family and truthfully retail.  There are going to be many renters for awhile as many people have credit issues leaving them to this alternative versus home ownership.  The vacancy rates are low and there are great opportunities in the marketplace.  Retail has a bright spot, I realize many reports suggest consumer confidence is down and yes Black Friday is soon approaching and CBNC and CNN are going to report the pendulum of our economy looks one way or the other based upon how many people shop in one day… good grief!  However, our economy is improving and spending is going to increase, it may not be at an all time high on Black Friday, however it is not like every American is going to weave their own clothes, grow their own food, and  milk a cow or goat every day.  So, investing in retail is a good long term strategy.

I always enjoy listening to the many viewpoints of my investors, as there is always something to be learned from others.  Most everyone is positive, so thank you and based upon your optimism and my own viewpoint, let’s keep our personal economies moving forward with a little faith and belief.  And by the way, I am proud to be a capitalist and hope you are too!

Cash-On-Cash Return

Cash-on-Cash Return measures the velocity of your money.  It can be described as how long an investment pays back your down payment.  For example, if your down payment is $20,000, how soon would your monthly cash flow add up to $20,000.  If you cash flow added up to $20,000 in one year, your cash-on-cash return would be 100%.  If it takes two years, your cash-on-cash return would be 50 percent.  If it takes three years, it would be 33%. 

Commercial Real Estate Investing can produce amazing returns.  Cash-on-cash returns of over 100% is not uncommon.  Now, if you were to go to your local bank and deposit $20,000 into its most aggressive CD investment for one to three years, what type of a cash-on-cash return could you expect?  Maybe 2% to 4%?  As an investor, you place an emphasis on cash-on-cash return when you invest simply because you need to know how quickly you can get your down payment back, so you can reinvest it into another project.

Strategic Negotiation

Commercial Real Estate Negotiations

Preface:  There is more to negotiation than what I can write in this post, however feel there are key strategies to consider when negotiating and wanted to highlight some key points.

Real Estate Negotiations is much more than getting what you want.  It is about making sure the interests of both parties are maintained.  Sometimes negotiations may continue throughout the course of a transaction to the very close; it doesn’t necessarily indicate things are not going well, however there may be new developments which change the nature of the transaction.  The real key is to become a strategic negotiator understanding the needs and interests of both parties.

Too many investors/brokers get caught up in only defining their own needs and desires and forget the other parties also has needs and desires.  Thus, they create an adversarial relationship which will not lead down an easy path.   Rather than being difficult, it would be more beneficial to determine the key interests of both parties and begin to create solutions which may involve some compromise to create a win/win opportunity for both.

I attended an advanced negotiating workshop led by John Shulman, an interest based negotiator and Harvard Law School graduate.  In his two-day workshop, John shared many key points.  He said in defining success, maximizing the satisfaction of your interests is different than winning.  Other factors to consider were to create an overview of your desired outcome and the outcome of your counterparts, to avoid internal and external conflict, focus on long term versus short term interests and assess outcomes against internal goals. 

John created a negotiation matrix consisting of stakeholders and their interests.  He then created a criteria consisting of a three-tier assessment of importance for stakeholder interests: (1) Critical (2) Important and (3) Not Important.  Critical interests are often deal breakers, Important interests are not deal-breakers to stakeholders, but create good opportunities to create value and Non Important interests can often be ignored.

I strongly feel a good strategic negotiation leads to a cooperative attitude between the parties.  Obviously, the goal in most real estate transactions is to have two happy parties at closing getting basically what they want.  Common Negotiation Examples to Consider:  Buyers many times fuss about making earnest money hard when if they are confident the lender will get closed, it should not make a difference.  Many sellers likewise are concerned about a quick due diligence period, when in reality in our new marketplace lenders are experiencing long delays with underwriters and securing secondary lenders is not a slam dunk.  If the goal is to get closed, does 4-6 weeks additional time really make a difference?

Gary Tharpe, CCIM wrote, “Salespeople know they should “always be closing.” Likewise, good negotiators test the progress of negotiations not by asking for the order, but by frequently testing how the other side currently feels. Are its interests being met? Does the other team buy into a particular solution? The Godfather's lawyer said his client “insists on hearing bad news immediately,” and so should you. If members of the other side aren't going down the same path you are headed, stop and find out where they are. Testing accomplishes that.”
Keeping the end in mind is the key factor in today’s negotiations as the marketplace is complex.  Not every deal is the same, situations can change and make the simplest become the most complex.  Flexibility of the parties and keeping the interests of the other party in balance is key.  John Shulman stated, manipulation does not satisfy interests rather facilitation satisfies legitimate needs of both parties.  The point I want to make is you must understand the needs of both sides in a transaction, create transparency built around trust, understand needs, satisfy needs and be clear on the consequences if needs of both parties are not met.

The bottomline to remember is to always stay strategic keeping the needs of both parties in mind to achieve a mutual ground of understanding which leads to a successful result.

Happy New Year!

Happy New Year 2011!

This year will be a great year of opportunity for commercial real estate and your chance to become more prosperous.  The brisk retail sales for this past holiday season has created renewed optimism among the all the news organizations which so unfairly influences the masses.  As of late, I have been engaged in the placement of several new leases and there are signs of decreasing vacancy.  This is definitely an indicator of renewed vitality in the marketplace.  Obviously, most lenders are still skeptical and rightly so about speculative projects; however there is money out there available for the most assertive of investors.

Capitalization rates have been falling on some credit grade investments such as Walgreens from 8-8.5% earlier in 2010 to 6.5-7.3% late in the year.  Many investors have sought shelter from the volatility of the stock market to a more qualified risk of guaranteed returns.  This combined with no new construction of these types of projects has created compression in the marketplace to drive down CAP rates.  Medical Office Building projects are becoming quite popular and I believe before the year 2011 ends, there will be a gradual return to the retail segment as a viable investment.

I recently attended a small group presentation led by Eugenio Aleman, a senior economist from Wells Fargo.  Eugenio said, ‘during the recession, our country lost approximately 9 million jobs and the current rate of employment absorption is approximately 200,000 jobs per month.’  He calculated according to this estimate it will take approximately four years to achieve some sense of normalcy.  He also related most likely we will not see a realistic return of new home construction until this time.  Eugenio also indicated interest rates will most likely rise following the fluctuations of the treasury markets and those involved in the bond market might re-evaluate their positions.

For the savvy investor, there will be many more opportunities this year to find incredible buys on properties especially in major markets throughout the Midwest and Southeast.  A recent auction in Indianapolis where a property sold for a fraction of the market value is a testament to this prediction.  Opportunities will be popping up in many places, but only those who take heed will be the real winners.  Now is the time to build relationships with new lenders and re-establish former relationships to position yourself for great opportunity.   We are still in Phase I of the real estate cycle, the expansion phase and like the old adage says, “Buy Low – Sell High!”  We are in the buy low timeframe.

In regard to multi-family housing opportunities, decreasing vacancy and improved stability in the economy makes these opportunities ripe for the picking.

So evaluate your position and set your goals for 2011 and take advantage of this moment in time.

Interest rates are still at all time lows, properties are everywhere, and economic growth has only way to go and that is up!

I look forward to discussing with you investment strategies and opportunities in 2011, so please contact me. 

Have a Super 2011!

Rob

Book Recommendation: "The Millionaire Zone"

A Memo to My Investors:
There is literally a multitude of literature in today's marketplace and articles all over the internet about how to get rich.  Of course, we all want to be wealthy, and my goal in life is to help my clients shorten the distance between the results they desire and where they may stand today.
Therefore, in the spirit of empowering your goals, stop by the bookstore or get online and purchase the book, "The Millionaire Zone" by Jennifer Openshaw.  She has great insight into how to become wealthy into today's environment, the book was published in 2007.  She has an online questionaire to create a 'millionaire zone profile' for you.  To answer the questions and get started today, go to http://www.familyfn.com/.  

You will discover in her book she highlights we should stay in our comfort zones and utilize the network of connections we have to be successful.  She makes a case that the rugged individualism we have witnessed in the past by successful millionaires is not necessarily the best or easiest way to reach your goal in today's environment.  Jennifer writes, "trying to do everything yourself leads to cascading results...  Individualism - Isolation - Inactivity."  She also creates a wakeup call for people thinking saving money in your 401K or placing it into a a savings account will make you wealthy.

Obviously, I do not want to give away all the secrets of her book, and no this is not a paid endorsement, however I believe it may be worth your while to read.

Have a Super Day!
Rob Millman

CRE Investment Criteria

1. Price range:  most investors seek properties between $700K and $15M.
2. Property types: most if not all investors want to invest in retail properties and office buildings where tenants have long term low-risk NNN leases, i.e. tenants pay for property taxes, insurance and maintenance expenses, in favor of landlords.  They prefer not to invest in apartments where leases are mostly riskier gross, i.e. landlords pay for taxes, insurance and unpredictable maintenance expenses.  Besides, apartment tenants normally don’t have much money which may affect their ability to pay the rents in a timely fashion.
3. Cap rate: the return of investment must be “reasonable”, i.e. generally higher than the interest rate.  The cap rate is typically lower in Western States like California and higher in other states.  However cap rate is not everything.
4. Property condition: investors prefer properties with little deferred maintenance.
5. Demographics: the selected properties tend to be in growing, high income and bigger cities/metros as they have better chance to appreciate and easier to find tenants.  Besides they are easier for disposition if required.  It is best to stay away from geographic areas where the economy has been struggling.  Properties in these locations are easy to purchase but much more difficult to sell.  In addition, it’s hard to get attractive financing, if at all, for these properties. Properties in remote areas are tougher to finance and sell.  These are also easy to buy but difficult to sell. Properties in cities where the average household income is way below the national average, e.g. $28,000/year, also will be screened out as these are most likely high-crime areas.  
6. Occupancy: close to 100%.
7. Good Visibility: properties tend to have most if not all units facing the road to show case the tenant businesses.  Tenants love visibility.  What’s good for tenants is also good for investors.
8. Great locations: properties on a major artery with heavy traffic, near the freeway exit, on corner lot, near a mall, on an outparcel to a shopping center.
9. Land: if land is not included then it does matter how beautiful the property is, it will not be selected. This is the type of property that is easy to buy but difficult to sell. 
10. Lease Type: most likely NNN leases.
11. Parking spaces: at least 4 spaces per 1000 SF of leasable space.  It’s difficult to lease a retail property unless it has sufficient parking spaces.
12. Age: not over 20 yrs old unless the property is well-maintained or recently renovated.
13. Price per square foot: sometimes a property is selected because the price per SF is low.  The main reason for the selection is appreciation potential.
14. Low rent: there is upside potential if the rent is below market.  When the leases expire, the rent is adjusted to market rent which increases the value of the property.  
15. Financing: sometimes a property may be selected because it offers attractive financing.  For example, the seller is willing to carry 80% LTV at low interest rate or buyer can assume a loan at 5.5% interest, fixed for 10 years.  This in turn may increase the overall return or cash on cash.  On the other hand, a property may be screened out because it is difficult to get reasonable financing.  For example, in this tight credit market it is extremely difficult to get financing for a single-tenant mom-and-pop restaurant.
16. Environmental: this is an obvious criteria, you want to purchase a property without environmental contamination or risks which could adversely affect the value of the property.