Investing In Retail Shopping Centers: Your Ultimate Guide To Success With Logan Freeman

Ditch the multifamily and set your sights on retail real estate riches! This episode unlocks the secrets of shopping center success with Logan Freeman, a $300 million-dollar acquisition pro. Together with Ava Benesocky and August Biniaz, he dissects the current market, navigates rising interest rates, and uncovers hidden opportunities in undervalued retail properties. Logan shares his winning strategies for tenant mix, anchor tenants, and mastering the art of retail leases. From juicy cap rates to 15% annual returns, we cover it all. But it’s not all sunshine and leases – discover the potential pitfalls and how to sidestep them. So, if you’re ready to transform retail centers into cash cows, buckle up and join the gold rush! This episode is your key to retail real estate domination.

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Important Links

• Logan Freman – Past Episode
• FTW Investment
• Never Split The Difference
• Mental Models
• Live Free Investments – LinkedIn

 

About Logan Freeman

Logan Freeman, with over 6 years of dynamic real estate experience, has executed over $300M in acquisitions for his firm, FTW Investments and as the head of acquisitions for a prior investment fund. Logan is also the managing broker at XchangeCRE, a boutique commercial real estate brokerage firm specializing in 1031 transactions. Leveraging his unique blend of people skills and transactional expertise, Logan is a driving force in acquisitions, capital raising, and investor relations, and serves as a voting member of the firm’s investment committee.

 

 

Investing In Retail Shopping Centers: Your Ultimate Guide To Success With Logan Freeman

We’re bringing back a guest. Logan is one of our first guests to ever come back. Was there ever a guest that came back?

I don’t think so. I think Logan is. He was fun to talk to. We couldn’t wait to get him back.

He was fun to talk to. We learned a lot from him. He’s a value add. We enjoy having him in our circle of influence and our sphere of influence. We learned from him. We’re going to talk about that on the show. Why don’t you go ahead and introduce our guests and hit this off?

We’re joined by Logan Freeman. With many years of dynamic real estate experience, he has executed over 300 million in acquisitions for his firm, FTW Investment, as the head of acquisitions for prior investment funds. Logan is also the managing broker at Xchange CRE, a boutique commercial real estate brokerage firm specializing in 1031 transactions. Leveraging his unique blend of people skills and transactional expertise, Logan is a driving force in acquisitions, capital raising, and investor relations and serves as a voting member of the firm’s investment committee. Thanks for being here, Logan. Welcome to the show.

Thank you so much for having me back. So much has changed, evolved, and developed since we’ve talked. I’m excited to be here with some of the best hosts and people that I know in the industry. I appreciate being here.

 

 

Market Recap

Thanks. We had you on our show a few years ago, but there’s been a lot that’s happened in the world of real estate. Can you cover some of the stuff that went on?

You have to think about the biggest player in the market, which is the interest rates for debt that goes into commercial real estate. That has been a theme that a lot of people have been focusing on. Rightfully, 2023 was a year of contrast. Some sectors were surprised by the resilience, and new opportunities emerged, while others faced greater challenges than anticipated. What I’m trying to get across to most real estate investors at this time is that in the headlines, you may see commercial real estate recession happening, all this debt that is looming and coming due, but you have to focus on the details and the fundamentals, not only from the asset classes that they’re speaking about but the geographic locations.

For example, we all know that office has been challenged, and that is probably a theme that was happening pre-pandemic, but also, the change to a hybrid workforce and/or working from home exacerbated that theme on the other side of things and on the multifamily side. We are now starting to see over 670,000 units to be developed and produced on the multifamily side. That’s almost double what we have averaged in the last few years, and they’re highly concentrated in certain markets. The headlines are one thing. They’re clickbait a lot of times. They want you to click on that article. When you get into real estate fundamentals, many sectors have strong fundamentals. That is an important piece to keep in mind.

What the challenge has been for the last few years is, “How do we get deals done?” With the seller and buyer void that we’ve had with prices and with where debt is that has created an imbalance in the marketplace, there is no equilibrium. That’s starting to change, in my opinion. I’m starting to see transactions happen, especially on the smaller side, $1 million to $3 million type of transactions. The other thing that happened was that 1031 exchanges dried up. I can speak to that because our brokerage is called Xchange CRE for a reason. We represent a lot of 1031 exchange buyers.

They weren’t selling their properties because they didn’t think they could get the price they wanted. We have bonus depreciation potentially coming back here. That could be a big driving force. The other thing that I’m tracking here is the 18.6-year real estate cycle. For the last hundreds of years, you can look at real estate prices going up for 14 years, coming down for 4 years, give or take 2 years. I’m studying and trying to understand where we’re at in the real estate cycle to position ourselves and our investors in the right places to make sure that we capitalize on this real estate cycle.

The other trend that I’m seeing is a lot of equity investors starting to turn to debt investors. This trend is important for two reasons. 1) Investors may be looking for a different opportunity, but 2) People are worried about, especially multifamily debt coming due, but there have been billions of dollars. Over $402 billion of dry powder has been created into fund-like structures, either debt or equity structures, to help these investors out in these deals. When Jon Gray, the COO of Blackstone, says, “We are seeing the market bottom for this cycle,” I believe his assumption is correct because the Green Street property price index has increased 0.3% since January 2024 and is trending upwards.

A lot of equity investors are starting to become debt investors. Share on X

On the whole index, we are exactly where we were back in the valley of COVID-19. A lot of investors are saying, “Basis is good right now. How do we make those deals work?” That’s a completely different conversation in regards to the capital stack, leverage and different things. I see 2024 as the start of the next two years of deal-making happening.

Equity Investors To Debt Investors

There is a lot to unpack there. There are a lot of interesting topics you brought on, such as bonus depreciation coming back, we’ll talk about that. The 18.6-year real estate cycle has been going on for almost a couple hundred years. We’ll talk about that. We have some questions coming up, but let’s talk about investors going from equity investors to debt investors. Maybe we can break that down a bit.

What I’m seeing is a lot of syndicators who are over-leveraged and got these risky loans. At CPI, we haven’t done a deal in twenty months. In retrospect, it was a great decision because deals were not making sense in an increasing interest rate environment. There were a lot of groups that had large numbers of employees, and they had to do deals to keep the lights on, so they went in.

These deals are maturing, are about to mature, and they’re finding themselves in a pretty bad situation. I’ve noticed a lot of them are starting debt funds and in their PPM, even in their fund webinars, they’re openly saying that the fund they’ve created is to rescue some of their own deals. How much of these rescue funds do you see coming up with investor interest wanting to go from investing as equity into debt? How much of it is syndicators or other groups trying to save themselves?

I think that it’s both. What I always like to try to do is what the 800-pound gorilla in the room is doing. That is Blackstone. They manage over $1 million to $2 trillion in assets. They themselves have over $202 billion in their war chest. I’m looking to see what they, KKR and some of the other big asset managers are focusing on. What we’re seeing is that they are switching their allocations from equity to debt to levels of about 20% to 25%. That matches back to where we were in 2018. I think that they are looking at these opportunities as, “Can we become the bank and the equity for those deals until we can go get some different loans that might make sense?”

That is one trend that is definitely happening on much larger deals on a larger scale. However, the other type of investment that you have discussed and described is rescue capital. This is where people need to either go and put more money into the project because they weren’t hitting projections and/or they’re not covering their debt service coverage ratios and their covenants. Frankly, I think a lot of these operators, and unfortunately, the basis may be too high for them and/or their investors. What I’m wondering, and what I’m interested in seeing, is what type of control provisions are created with this rescue capital, meaning the fund that’s coming in to put more capital in.

I highly doubt that they’re willing to put capital into a project that they don’t have control provisions to take over that deal. Is it rescue capital or is it more predatory lending? That is what people have to discern. Regarding these sponsors raising funds to put more money back into the same deal, the PPMs should sometimes allow for member contributions that are either equity or debt. There needs to be a strong story in regard to, “What is that capital going to be used for? How is it going to be paid back? How does that impact my equity return?” I have not been a part of and/or seen any opportunities where folks have gone to their investors and/or other investors and said, “We need to put more dollars into the project. However, we’re going to do it as a loan then,” and that be successful.

 

I’m sure that is happening. However, it’s a confusing position to be in as an LP when you get that call. I’m going to put more money into the project as a loan. How is that going to impact my returns on the equity side versus, “Is this just a way to try to save the deal? If you have debt that is not coming due, I would say that might be a good option.

Now, if you have debt that’s coming due, we know that the capital markets are still in disarray and debt service coverage ratios need to be able to get to 1.3 or above, which needs to be on a trailing 12. Unfortunately, a lot of that is not happening because of the basis and/or the new supply that’s coming online, which is creating rental price decreases, not increases, in certain asset types in certain geographic locations.

It’s very specific use cases. Each one is unique and different. However, if you think that there’s an option to put money into a project, whether that be on the debt or the equity side, and you can get it stabilized to the point that you’re not worried about another interest rate increase or something along those lines, I would say that might be a good opportunity. If we’re saying, “We need to put money into the deal to get stabilized and we need to refinance this loan,” that’s a tough position to be in, and it is going to be interesting to see how it plays out. I haven’t seen any of those scenarios yet.

I think some of these groups are doing it not to make capital calls to their investors but rather bringing on this form of quasi-debt, but it will dilute their investor returns for sure. I’m wondering how the mechanics of this works but they’ve openly advertised it as if they’ll be rescuing some of their own deals. I’ve noticed a bunch of syndicators in my inbox are advertising this.

Raising capital for the debt fund.

Do you know why? True preferred equity cannot be put into a deal typically. There are scenarios, but it’s very difficult to put that into a deal behind an agency loan. Those loans are very tight with their covenants and the restrictions that they have. They’re looking for ways to infuse capital. I think that there needs to be a strong plan on how you get stabilized and how that capital is returned.

Retail Shopping Centers

You own your own farm, FTW Investments. What do you guys do? What asset class do you focus on and what’s your guys’ business model?

It has been transitioning and shifting as we have been doing business since late 2018. We got started doing Class C multifamily apartments and value-added apartments, and as we all know, that market got heated up, so we were not finding any opportunities. Similar to you guys, we’ve only done one deal over the last 24 months. We’re in that same boat. However, we reposition our investment thesis into more commercial assets. This is a reposition because, going into COVID-19, we had about $35 million of neighborhood retail shopping centers under contract, and then the pandemic happened, so we had to reset our focus. We’ve been stepping back into the commercial real estate space and have added around 600,000 square feet of commercial assets into the portfolio.

These are neighborhood retail shopping centers and flex industrial properties. The reason is I’m able to find solid mom-and-pop owners who have owned an asset for 15 to 20 years, and they need to have the parking lot redone. They need a new roof, new facade, lights, new signage and all of those different things. Unfortunately, they’ve used the asset as a way to live a certain lifestyle. They weren’t keeping money back into different reserves to put back into the deal. Now, they might be at 80% or 85% occupied. To get them released, money needs to come into the project because commercial tenants are a lot different than residential tenants in the sense that they’re signing a 5, 7 or 10-year lease and if they’re changing the use of the space, that build-out can be very costly.

For a lot of regional and local owners of businesses, they don’t have the cash to put into that space. As an owner of the building, you need to be able to structure a deal in regards to, “You guys are going to put in this much. We’re going to finance the rest of this build-out for you through either the construction loan that you have and/or the equity that you’ve raised, and we’re going to lock you into a 5, 7 or 10-year lease, but the build-out is going to be very costly.” That’s good for the property owner because those are typically sticky tenants. Let’s think about a dentist. If a dentist is going to start a new practice, we sign a big dentist lease in one of our shopping centers. They have a massive build-out.

Not only that, but they also have a large amount of costly equipment that needs to be bought. They are building a practice, a business, and a customer base in that shopping center because it’s surrounded by the folks that they want to serve. That is extremely sticky in that regard, and I love that opportunity for these shopping centers and these flex industrial properties because tenants typically do not want to leave if you have a good located building because they’re building a business inside of that. If you go to the residential side, I’m not necessarily stuck to that residential building if I can find a cheaper apartment down the street that has the same amenities.

We’ve been transitioning our investment thesis into this space. If you’ve watched the Wall Street Journal, they’ve started to hone in on neighborhood retail shopping centers and the trend that, “Eighty-six percent of all retail sales still happen in brick and mortar locations.” That means the web penetration is only at 14% and peaked during COVID-19 at 16%. That’s over $4 trillion. Industry is the retail trade. One in four Americans are employed by some sort of retailer. It’s a huge industry.

Does food fall under retail?

Yes.

People don’t have a choice. They can’t go on Amazon to buy a pizza. We’ll break down retail and shopping centers in a moment here, but talk to us about the shift that you guys made here at CPI. We’re focused on multifamily and internally through the difficult times we’ve had over the last few years, rather than expanding our bike criteria, we became more focused to focus on Florida, particularly Jacksonville, Tampa, Southwest Florida and West Coast. This idea of expanding and looking at other regions, potentially looking at other asset classes, seems a very difficult task. Talk to us about that transition. Did your experience as a broker, managing and having other team members make the process easier because you understood the business model and how the business ran? Talk to us about the transition and the shift that you guys made

To add to that, maybe you can talk about what it was like for investors because you get them about multifamily.

We’ll get into the investors. We’ll focus internally on your team as GPs because I’m going to get into the investors as far as what type of economics they look for when looking at retail compared to multifamily. I’ll get into all of that. Are they cashflowing? I’ll get to that in a moment, but talk to us internally as a GP. How do you guys go about learning about this new business, which is possibly vastly different from multifamily value?

I’m going to clarify that going into COVID, we were focused on neighborhood retail and not multifamily. It went from neighborhood retail and commercial assets to multifamily, back to neighborhood retail and commercial assets. Why? I had done a lot of retail brokerage in my past life. We had a lot of 1031 exchange buyers who were interested in buying stabilized neighborhood retail shopping centers. I had been a part of many of those transactions. I saw that value. However, they were typically looking for something that was stabilized. I wanted to go in, find the asset that needed the value to be added and then stabilize it. That way, I could compress that cap rate. One thing that I will mention as well is that one of my business partners has been in the retail, office brokerage leasing, and development space longer than we have in the multifamily space.

It was a pivot from commercial to multifamily back to commercial. We have managed this by using our strengths and skillsets on the retail side before they were on the multifamily side. We have hired a 35 to 40-year veteran on the commercial property management side to manage those assets. Bringing somebody with that expertise to be able to manage those assets has been extremely important as we have transitioned, built investor confidence and go implemented the business plans. Business plans are an important part to speak about because these are more or less larger CapEx projects and less of internal rehab units. You get to work with large contractors that focus specifically on asphalt or specifically on painting the building, lighting, facade or something along those lines.

You get to deal with larger companies that are specialized instead of the trucks in the truck that show up and can do the electrical, plumbing, painting, drywall and those types of things. Managing that process is a lot easier on our end. The hardest part with neighborhood retail is how the leasing is going to work. This is all about location. We work with 2 or 3 different leasing groups here in Kansas City that specialize in specific geographic locations. I want to point that out very importantly because one leasing team may be good at Johnson County on the Kansas side, and one may be good at Eastern Jackson County. People have specializations in regards to leasing, as property managers would, but you wouldn’t hire a residential property manager to manage a 615,000-square-foot portfolio of commercial.

The hardest part with neighborhood retail is how the leasing is going to work, which is all about location. Share on X

What’s been important is to make sure that we have the right vendors for the right assets and then have the internal team bringing our skills and experience, but also hiring on the property management side. One property manager can manage anywhere from 500,000 to 600,000 square feet because you’re not dealing with 500 tenants. You’re dealing with 50.

Are retail shopping centers always triple-net?

We love to buy modified gross and gross leases, implement a business plan and then work with the tenants to move them to triple net leases.

Explain the difference.

You’ll typically have a mix of triple net leases. A triple net lease means that they’re going to pay their portion of the taxes, insurance, and common maintenance, but you may have a tenant in there that is paying base rent and they have a flat fee for utility or something along those lines. That would be more or less a gross lease or a modified gross lease where they pay a base rent and then they might take a portion of the taxes or a portion of the insurance. With the mom-and-pop, I have seen many different lease structures. It blows your mind what type of leases get put in place. Our goal is to go in and focus on adding value to the shopping center to show that we’re focused on 1) Elevating the safety and the look and feel of their customer base.

Implementing a robust leasing strategy will allow more traffic to those businesses. You have to look at the tenant mix very closely. You might have a chiropractor, a dentist, a veterinarian, a restaurant or a hairdresser. You want to make sure that somebody is going to show up at the shopping center and that they’re not just going to one location. They might go to 3 or 4 different locations in that shopping center. If you can show that you’re adding value, making the cosmetics look better and making it more efficient to be an operator in that space, then you go to them and say, “I know your lease is coming up.”

We always look at weighted average lease term. WALT, or Weighted Average Lease Term, says, “On average, with this shopping center, we have twenty tenants. When are those leases renewing?” We’re looking for a weighted average lease term under two and a half years. That way, we can go in, implement this strategy and then renegotiate these leases. If the WALT was five, you’re buying a stabilized deal, and that’s fine for a 1031 exchange buyer, somebody looking for a coupon. We’re looking to be able to implement robust modified gross-to-gross leases to triple net leases to add that value for ourselves and for our investors.

That allows us at the end of the whole period to say, “We have done the roof. We’ve done the facade. We’ve done the parking lot. We’ve done all the HVAC and moved all gross leases to triple net leases, and now we can take that cap rate from an 8.5% cap rate that we purchased at and sell at the market cap rate, which is 7%.” That’s where the value starts to be created in these neighborhood retail shopping centers.

Anchor Tenants

Neighborhood retail shopping centers. Is there always an anchor tenant, or could it be without an anchor tenant? Is bringing an anchor tenant a value add or could it be negative? Talk to us about anchor tenants.

Your typical anchor in what REITs and large equity groups will look for is a grocery-anchored shopping center. We typically do not purchase those for a multitude of reasons. 1) The cap rate is usually a lot lower because if you have a grocery in there, you’re thinking the traffic is going to be high so you’re paying a lower cap rate. We typically focus on unanchored neighborhood retail shopping centers. We may have some national credit tenants in there, like a CIRC, a national franchise or something along those lines but we usually have a good mix of regional, local and national tenants in there.

What I’m looking for is not one tenant to take more than 20% of the gross leaseable area or GLA. That way, we could say, “Out of these ten tenants, not one of them is going to have a massive impact if they leave the shopping center.” We’re looking for that to be under 20% on these shopping centers, giving a diverse income mix. Maybe one industry goes down and has pulled down. Think about meal prep services. Those things were popping up everywhere. They had retail locations left and right.

During COVID, those things went away. We’re making sure that if one space leaves, it’s only 2,500 square feet, we still have 18,000 or 20,000 square feet occupied, and those leases are always rolling on different time periods. We’re also looking for anchor shopping centers. I’ve looked at a lot of national credit grocery-anchored shopping centers. We’re not as competitive with those deals because larger groups with lower capital costs typically come in and buy those.

If you have the square footage, could it be part of the business plan to build out a unit for an anchor tenant and that’s the business plan? Could that ever be the case?

Think about these four as suites in a strip center. Depending on how it’s configured, you can take a wall down and create one 2500 square foot space into a 4,500 square foot space as long as you have vacancy on that space. With what we’re trying to do, we have 3 shopping centers within 4 miles of each other. I’m able to work with all of those tenants and say, “You’ve outgrown your space. We have a shopping center right down the road that we can move you to and make more space for you.” Once you get economies of scale in a certain geographic location, the leasing becomes much more robust because you have different options for these tenants. You can create more spaces for the right tenant as long as they are willing to sign the right type of lease.

 

Risks In Retail

In retail, what keeps you up at night? For example, in multifamily, some of our concerns are debt changes, hypersupply and rent dropping. What are the risks in retail centers? Are they the same?

I would say that they’re not building new retail shopping centers because they can’t around the suburban neighborhoods that we purchase because if there was land, what was built? A multifamily was built, and an industrial building was built. Typically, neighborhood retail has not been built unless there is an anchor tenant that you are going to build that shopping center for, and that’s usually a much smaller space and/or a single tenant net lease deal. What keeps us up is that there is a reason in regards to the tenant mix that we have that some sort of impacts like COVID-19 or a pandemic could impact these businesses. You have to look at whether it is the type of business that you have. Are they essential businesses? Essential businesses, even during a pandemic, were able to stay afloat.

Aside from a Black Swan event, is there something else that brings concerns? You were talking about having a good ratio, not having one type of business there. If that business goes down, it doesn’t affect it not having more than 20%, but what’s your guys’ biggest concern? It’s not hyper-supply because infill is difficult to build shopping centers, but is there any other concerns because I am a believer already? Tell me about it.

The main concerns for me are these tenants willing to buy into the program by moving from modified gross leases to triple net leases and paying market rent because the hardest part is a lot of times from buying a mom-and-pop is they’ve never raised the rent. It’s been $13 a foot modified gross for this last few years. It’s been difficult in some scenarios to get some spaces to say, “We buy into this. They just can’t pay.” The business model as well is you want to make sure that you don’t raise the rent high that you have large vacancies coming. The risk is you have to sit down with each of those business owners, learn about their business, their credit, what’s driving them, what’s not driving them, and see if they can even pay.

It’s much more of a forward-looking planning session with these businesses, with these tenants my biggest risk is we got a WALT of 2.5 in two and a half years, all those tenants say, “Bye, I’m leaving,” all at once. That’s the hardest part with these deals because if you do have a shopping center that only has 6 tenants, and 3 of them do leave, then you do have a large amount of vacancy and your cashflow goes way down. That can be counteracted by buying in the right areas that have sub-market vacancies lower than 5%, but you’re still going to have downtime. You have to plan for that accordingly. My biggest risk in most of these shopping centers is getting people to buy in and making sure that they move their leases from modified gross to triple that lease. That’s a business decision.

 

How about crime? You’ve seen Walmart closing down actual stores because of the crime and smash and grab or whatever you want to call it. How about crime increase in certain areas?

We look at these deals and median household income has to be above 75,000. For us to be interested, traffic counts have to be above 15,000 cars per day. We’re very specific about going into certain locations. We’ve mostly focused on Johnson County, which is the Kansas side of Kansas City. You’ve got Kansas, Missouri and Johnson County on the Kansas side. Good school districts, high median household incomes and the houses around there have disposable income to shop. That is very specific.

We’ve only bought in two different locations in Kansas City, which can be a detractor from growing this portfolio, but it is also why larger groups haven’t gotten into neighborhood retail. It’s very difficult to do at scale. Those are my thoughts on the crime. We’re not willing to go into any area that has high crime and/or that’s pretty easy to either know because I live here or looking at the statistics.

Underwriting

You guys are not remote investors who look at something online and make an investment. You have been in the area for a long time and understand it intimately. Barry Sterling was talking about this idea of partnering with local experts, and you guys are definitely local experts. You know what area makes sense and what doesn’t. Let’s talk about underwriting. In multifamily, there are certain rules of thumb, like 50% of the NOI goes to management costs. What are LPs would invest in? What type of debt exists for a multifamily? Certain rule of thumb. Is there such a thing as retail shopping centers? What kind of cap rates are you guys using? Give us a breakdown of how you underwrite and what you look at.

Basis is the number one thing. We’re not looking at per door. That’s not what we do here. We look at per square foot and what am I purchasing per square foot? Even if you take a deal from an 8.5% cap rate that you purchased at, and you believe the market cap rate is 7% after stabilization, if that per square foot is $100 more than what the market is saying, you’re probably not selling at that. That’s very important to notice because per square foot versus per door on a cap rate on NOI are two different things. We’re looking for deals that have anywhere between $85 to $125 per square foot in good locations because I know it’s going to cost somebody $240 to go build this thing, and there’s no land to do that.

I’m insulating myself from a basis standpoint, number one. The second is a vacancy. This is much different than multifamily because you have to stage the different vacancies. Cashflow can be very lumpy in these deals based on when the leases are coming due. We have to use a program that is very similar to argus, which looks at the leases, looks at what they’re paying for the triple nets and/or what they’re paying on taxes and insurance when those are rolling, then make some bets on the probability of them renewing their leases versus leaving the shopping center. That’s a pretty complex process that we use a very specific underwriting tool to help us understand and look at, but rules of thumb, 10% vacancy, hold it at that all of the time and make sure that you keep 4 to 6 months when a property or a space is coming for renewal that you have to make the space available for somebody else and then downtime on the leasing side.

How about rent growth?

Rent growth is unique in this scenario, too, because we’re looking at a lot of these deals. The market may say it’s a $18 triple net lease, but somebody’s only paying $13. It’s like, “Do you bump them up to $18 per square foot?” Rent growth has been between 2%to 3%. The highest year in 2022 was closer to 4.7% here in Kansas City, which is great on the retail side. It’s still continuing to stay positive and grow because there’s not as much supply for these spaces. That’s that.

On the cap rate side, we were selling these things, pre-COVID at 8.25% cap rate stabilized. That has dropped and it has dropped substantially in certain submarkets because people have started to say, “I’m looking for something that’s a little less headache. We had a lot of 1031 exchange buyers coming into the market.” People are looking for different diversification because I feel like a lot of folks have gotten over-allocated to some multifamily. When the Wall Street Journal started posting about the darling of the industry, which is neighborhood retail, we saw firms like Nordstrom creating smaller footprints in shopping centers and neighborhoods. That’s driving a lot of capital into the space.

We’re typically trying to buy above an 8% cap rate and looking to get back down to a stabilized cap rate between 7.5% to 7.75%. We can sell these things for a little bit better than that, but I don’t ever like to be super aggressive because going back to the per square foot basis, we have to make sure that we’re in line with the historical trends because I can’t say that the next five years retail shopping centers are going to sell for $225 a square foot. There may not be a market for that. The great thing about these things is they typically cashflow. If you’re buying an 8% or 8.5% cap rate, there’s usually a good plan to get occupied and then they stay occupied because you have longer-term leases and you have time to plan for the rollovers.

Long Term Leases

These long-term leases when it comes to industrial and retail, are helpful because you know what the tenant is paying and it’s pretty difficult for those tenants to make a switch. Real estate has a very wide spectrum of rates where hospitality is used. They can switch their rates on a daily basis, then you’ve got industrial and retail, which is in some cases ten-year lease. Talk to us about the positive and negatives of having these long-term leases in place. At times when these contracts are made, there’s a clause where, depending on certain circumstances, the owner can increase or decrease it by the rate of inflation. Talk to us about that.

There are a lot of different lease structures. Based on the size of the business, the credit quality of the business, you have to make those decisions. I have seen it done multiple different ways, whether you have regular renewals, increases based off of the years that you have in your contract or your lease with the tenant, or you can tie these things to CPI. The challenge with that is where we’ve been the last couple of years with the inflation being 8% or  9% or whatever the metric is that you want to. Can a business pay that? That’s tough in those kinds of scenarios. The downside would be, “You’re locked into a long-term lease with someone that you don’t have a lot of renewals.”

Rate increases during those renewals. If they are triple net leases, you are insulated in a scenario with what we’re seeing in the insurance markets right now to say, “Insurance has gone up 200%.” You can pass through a lot of those costs, but can you pass through all 200% to your business that’s in your shopping center? That can be tough. You have to have some leeway and flexibility with these lease structures and what you’re going to enforce.

You have to have some flexibility with these lease structures and what you're going to enforce. Share on X

With most national credit tenants, those things are negotiated very strongly with internal real estate teams and everything is lined out. With more local and regional tenants, you have to be involved in that and say, “Our taxes went up 100%. Our insurance is going up 100%. What can you do in regards to increases?” You may have to stage that over a certain amount of years and/or weren’t willing to work with them on some sort of financing situation.

Is ever the business model switching the zoning from retail into some type of mixed-use to increase returns or what have you? I’ve seen a lot of malls closing down in Metropolitan cities. Now, they’re building high rises in the location of the mall. Is that anything that e ever happens in retail where a portion is used for mixed-use or building condos or apartments?

I have seen that happen with some malls, and more or less, the malls are moving to a medical type of use, maybe a big urgent care or a hospital system that needs more footprint that would go into a mall. What we see more regularly is you buy a shopping center that has a large parking lot and Scooter’s Coffee, or a Chase Bank contacts you and says, “I’d like to take this out the parcel and build a building.” Now, you’re structuring a 20 or 25-year ground lease with a Chase bank or a Scooter’s Coffee from a part of your parking lot that is valuable. You could sell the real estate after that ground lease is in place to a single tenant or net lease purchaser and/or sell it to the operator who’s willing to build their space there.

We’ve done that in a shopping center. We had an outparcel building. It was knocked down. Community America Credit Union came in, bought the land and built a brand new building right there. It infused $700,000 of equity back into the deal. We were almost at par with the equity on that project. What I see more often is being able to buy a shopping center, as long as you have enough parking requirements taken care of, configuring your parcel, and figuring out what to do without a parcel to add value to that whole opportunistic deal. That’s what I’ve seen.

I do want to mention one thing. I have been a part of some transactions, in the Crossroads and the Kansas City Royals announced where their new stadium is going to be. I’ve helped some owners redevelop some mixed use buildings, whether that be retail on the main level and apartments up top are short-term rentals. They have had to go through some changes of use and/or zoning, but now they’re sitting in an area where the Royals need to purchase their real estate. Again, location, but I’m working with those owners.

LP Economics

If you find any of those deals, make sure you let us know. Let’s get into LP economics. Ava was eager to get into this in investor relations. You’re talking with investors on a daily basis.

Talk to us a little bit about the LP economics. Are these deals cash flowing out of the gate? I’m curious how long, what’s the whole term for these types of deals that you tell investors?

We’re not buying negatively leveraged deals. We are typically purchasing these at an 8.5% to 9% cap rate on current income. That’s tough to do, but that’s what we’re doing to make sure we insulate ourselves against any market downturn or any type of exit strategy. That’s important. The cap rate is much higher than most multifamily opportunities. We like to buy buildings that are at least 70% to 75% occupied. That’s going to be cashflowing very little for the first twelve months, but it allows us to have enough cash flow into the project where we’re not having to do something to the deal to pay the loan off to make a preferred return payment to our investors.

We typically say there are going to be 3 to 4 quarters on these value-added retail shopping centers before we’re going to start making distributions. We’re building up the war chest. Why? We don’t know if when we take over those tenants told us they would stay up and leave. We’re trying to get in, take over the management side, build the relationships for a good year, get a good philosophy of who’s staying and who’s not, and then we can start to make sense of, “Should we distribute capital to our investors where we at on the leasing side?”  On day one, we are starting on that CapEx program. Those tenants see that we’re redoing the parking lot, adding signage, adding lights, and making the shopping center more available to them.

What this amounts to for LP investors is usually an 8% to 9% cash-on-cash return is pretty steady when that gets started. There’s not a whole lot of change to that. Equity multiples are anywhere between 2% and 2.5%. The internal rate of return is highly dependent on your exit. I can make that look a lot better than what it is. It is usually 17% to 19%. They’re not very sexy deals, but they are a nice compliment to other opportunities that may have a heavier value add and/or less cash flow, during the hold period. Hold periods typically tie it up with the debt. If I’ve got a five-year loan, I’m going to model out at five years and then look at what an exit is.

The plan with this commercial real estate and this has been the plan all along, is buying good areas, invest, wait, and appreciate because I know that in these areas, if we hold this real estate long enough there is going to be worth so much. I was having a conversation with a guy yesterday in Nashville, Tennessee. We looked up some tax records that he was looking at, and somebody had bought an office building for $500,000 and now has a loan for $22 million. That was over 25 years. The kind of stuff that I’m looking for here is how we hold this in perpetuity.

 

 

My goal is to get a strategy implemented that we not only have 6 of these things but we have 60 of these things. If I have 60 of them, then I can go to a private and/or a public REIT and say, “You want exposure to neighborhood retail, but you haven’t been able to get to scale. I’ve got 60 deals across 5 or 6 states that you can step into and buy all at once.” I have not seen that done, and I think there’s a huge opportunity there.

Investor Profile

I’m curious, what is your investor profile? Do you see a conversion from the multifamily investors to this asset class?

Very few. It took a long time, 18 to 19 months of education on why folks should be interested in this asset class and why we are interested in this asset class. Most of the time, it would be new investors that have reached out to us after marketing had been in place to talk about the opportunities in the neighborhood retail and the flex industrial spaces. Industrial has been easier to transition multifamily investors over to maybe because the headlines say how hot industrial has been or is, or maybe it’s easier to understand, but you got to look at my investor profile, which is a lot of accredited investors from tech companies in California and/or other markets. They might be in the internet or software engineering space, and they may not utilize a shopping center in their market.

I’ve had a lot more Midwest investors who believe in these neighborhood retail shopping centers versus California investors who are like, “I buy everything offline. I don’t go to the grocery store.” I understand that. It has been a difficult proposition for them, but we have, we have transitioned a decent amount of those because I think the overall allocation to multifamily and/or maybe some of the projects that they’re in that aren’t producing the cash flow that they thought they were, they’re looking for some other type of diversification. It seems like the investors are definitely coming around.

A couple of quick questions for you. When you rent these units out, are you talking about CapEx and, and what have you? Are you renting out a shell and then the tenant comes in and builds what they want?

We will do that, but more or less the time, what we call it is a tenant and landlord contribution. We’ve got a package for the dentist that’s coming in and saying, “What’s the build-out need to look like? What can you guys afford to put into the deal? You need to put some money into the deal. What needs to be financed from our end?” We will amortize that over five years for them or their lease period, depending on what that looks like for them to get their build-out done. We have spaces that are 2000 square feet, 1500 square feet, they buy it or they sign the lease, they turn the key and do everything themselves. It ranges on the spectrum of what the use is going to be, but not a whole lot of build-out unless it’s going to be a medical use or something that is a huge change of use for us in these shopping centers.

Average Annualized Return

The next question, you mentioned cash on cash, IRR and equity multiple, but how about average annualized return is the metric that we look at a lot. For example, the reason we haven’t done a deal in a few months is because we haven’t been able to hit that minimum 15% average annualized return. Is there a minimum number in an average annualized return that you will not touch if it’s less than that?

Typically, similar to you, it is 15%. However, I will say that I’ve had a few investors with pretty deep pockets say, “If you get better credit, meaning more national credit, and you can find a 12% or 13% return and it has a 7-year lease on it with a person that’s a national grocer, I’m interested.” The hard part is finding that opportunity because those get bought for lower cap rates, which can be difficult. I got to look at this deal like this grocer is going to leave and if they leave, what are we going to do with that space? Am I going to have to attract another grocer? That could be a difficult proposition.

These folks will leave. National credit tenants will leave. We’re seeing it happen in Walgreens and CVS. They’re shutting their 15,000 square foot space down, going across the street, and opening up a 5,000 square foot space. That one tenant in that building demoralized the whole project’s return. Typically, it is 15%, but if it has a strong tenant and we do have an investor that’s asking for that and/or we know is interested in that, we might get a little bit more aggressive on that front.

We still have a few more questions. Debt. Who lends to you guys? Is it mainly private? Are agencies even an option for retail? Talk to us about that.

You can get a CMBS loan for a large enough project, but we have only used regional and local banks for these types of assets.

Those sometimes are pretty good. Regional banks have great rates. We’ve seen that regional banks have the best rates out there for single-family development.

That is a typical full recourse to the sponsors. It’s completely different from a guarantee standpoint, but that’s what we’ve worked with in the past. I would say that if we do get to 10 or 15 of these, looking at a large cross-collateralized loan across all of t these projects, it could make sense, but they need to start to get to being more stabilized. I’m using a regional bank because they’re willing to give a construction component to this to go execute that business plan.

Market Predictions

Let’s talk about predictions. It’s February 2024 here. What are your predictions when it comes to what’s happening with the interest rates and the debt aspect of our business? Do you believe Jerome Powell Powell, the Chairman of the Fed, is going to decrease rates three times?

I try not to bet against the Fed. They have telegraphed what they’re trying to do. I think that the markets had 7% or 8% cuts in the market that have been squashed now. I’m less being a prognosticator about where interest rates are. I’m more or less trying to understand where we at from a basis standpoint. Is that going to go up? Is that going to go down? What deals do I have coming for refinance? We started purchasing in 2018, 2019. 2025, that will be coming to fruition on most of my five-year fixed-rate deals. I have to be thinking about that. Do I refinance now? Do I sell now? What does that look like?

We go through a hold refi and sale analysis on a quarterly basis for each one of the assets to make sure that we’re staying in front of that. I do see some trends that, in my opinion, the prices across the board are going to start going back up for at least the next 16 to 18 months. I think that’s the 18.6-year real estate cycle that we talked about. That’s bonus depreciation coming back. That’s inflation easing. I know it ticked back up, but I do think it’s going to continue to ease. The Fed saying, “We’re not least raising rates.” They may cut, but they’re not at least raising rates. That’s creating investor psychology that is more confident. We need that sentiment that is more confident and a lot of capital over $450 billion has been raised and needs to be deployed into real estate deals.

I see that all trending in the right direction on from a price per square foot and, and price per door basis. What that looks like for us from an acquisition standpoint? I’m still uncertain, but one thing I am trending in looking at is there are more Baby Boomers turning 65 in 2024 more than any other time in history. What does that mean? They hold over $7 trillion of real estate. That’s on the residential side. I have to believe they have a decent amount on the commercial side as well. As these individuals do get older, they are going to be looking to sell that real estate because there are a lot of times where their heirs do not want to do anything with that. That does create, maybe in the next two years, some more transactions that are going to happen as well.

 

In January 2025, where are the rates going to be?

I sure hope that we can go get a loan at 5% or 5.5%. I’m looking at it maybe similar to 2018 and 2019.

So far it is going to be like at 3.5% then?

Yes.

Implement Ideas

The last thing we want to end the show with. Last time you were on, you taught us about this concept of immersion where you don’t just read a book. We hear a lot about, and a lot of times, things online and on social media about how CEOs read eight books a week. I call it BS on some of these things and it’s not reasonable. It’s not about how many books you read. It’s about what you learn and how you implement it you talked about when you read books, you immerse yourself in a book for weeks and months, and you try to use what you learn from the book and implement it in your life.

 

 

When we read a book, that’s what we do now every single time.

We get a highlighter out.

We get some sticky notes out.

We read it over and over again, and try to implement it in our lives. We want to know if you had any other secret sauces that you use in personal development that you talked about, cold showers on our last show, but maybe cold plunges that are in these days, but maybe on other things where you pretty much run two companies on your brokerage side and your private equity firm, and you have three children. Congratulations on the most recent one. Are there ways where you can implement ideas that you’ve learned from these books, in personal development or in building companies? Tell us something we can use this time.

Are you ready to be leveled up?

I’m ready to be leveled up.

This is a game-changer. Now that you have immersed yourself into a book, can you sit down with a ten-year-old and teach the concepts out of that book? Can you teach that concept to someone in a simplistic way so that they can understand it? That is the next level. One book that I will say how I’ve done this is, Never Split The Difference. I have been able to take the concepts of mirroring, labeling, accusation audit, tactical empathy and all of these things. I use those in coaching with my kids. I only have a 5, 3 and not even a 1-year-old. Being able to teach those concepts out of a book to employees and to other people. That’s the first one.

The second one is ChatGPT. Here’s where it gets cool. I have been messing around and playing with ChatGPT in the sense that those book reviews that I write, the concepts that I take out of those books. I put them into ChatGPT in a text format. I say, “Now that you have the summary of all of the concepts that I want, I want you to play Chris Voss, the negotiator on the other side, and we’re going to start negotiating this real estate contract live on ChatGPT and help me respond in a way that uses those concepts out of the book.” That is interesting because here’s another one. If you have Mental Models from Charlie Munger, you can upload mental models into Charlie Munger and say, “I have a challenge that I am trying to figure out how to think through the mental model of inversion.”

You lay out the challenge and you say, “Give me five different scenarios that help me to invert this and elevate my thinking.” Now you’re talking with Charlie Munger in regards to the inversion of that Mental Model. One cool way that I’m utilizing this is I’m big on personality and skills assessments, but that only gives you a marker. It gives you, “I’m an individualist. I’m an achiever. I’m a competition.”

What do you do with that? What I’ve done on the brokerage team is I’ve had them all take PrinciplesYou from Ray Dalio, which is a free assessment. I had them send me all of their results. What I did was load all of the results up into ChatGPT and say, “Here are the eight people that I have on the brokerage team. How do we best work together? More importantly, when a challenge comes up, how do we work through this challenge and tell me what challenges may come up between these 2 or 3 individuals.”

Compatibility.

You’re taking those concepts and can teach them, but you also can run almost regression models with ChatGPT with those concepts and do mock scenarios in those. It has been an absolute game changer for me to understand other people’s perspectives based on their strengths and their skillsets. Amazing. Wow.

We’re going to talk about this next time we have you on the show. Thank you for coming on. I appreciate your wisdom, as always. Thank you for taking the time to tell us about your new venture. We should definitely have a chat soon.

We always appreciate you. Thank you so much.

Thank you so much for having me.