I'm discovering a new asset class (with wild returns). Part I.
I'm trying to buy a modest retail plaza. That's a big departure from my multifamily portfolio strategy. I'm going to bring you along for my journey. Right now I'm going to be coy about the specific location and tenants. This is an (early stage) deal-in-progress. I just submitted an LOI (letter of intent) last Friday.
About four months ago I started introducing myself to commercial real estate brokers. I was up front with them that I was just learning. I don't like to waste people's time. One broker has been sending me listings and giving me their assessments.
I've looked at about 20-30 listings in all. Just to 'get a feel'. Specifically:
- Lease lengths and renewal terms
- Types of tenants
- Retail only vs multifamily + retail
- CAP rates
All these items are intertwined. You get a lower CAP rate for prestige/secure tenants in downtown areas with long but increasing leases. No surprise there. Change one variable and the whole equation changes.
I'm expecting 17% cash-on-cash returns in year 1 and 25% return on equity (before appreciation and depreciation write-off) if I get my preferred terms. Juicy.
The property I'm trying to buy:
- Has staggered leases with renewals in 2022, 2024, 2025, 2027 - all but one with five-year renewal options. Why I like this: there's ongoing/stable cash flow without being tied down to leases into the 2040s when the market may be very different.
- Has four retail tenants including a dentist, a quick service restaurant, a retail showroom and a professional services company. Why I like this: diversification means I'm not reliant on one tenant or one industry type.
- Is the first retail plaza just off the main route to a major vacation spot. Why I like this: this vacation town is a long-standing and popular destination. It's almost impossible that the main artery won't always have traffic.
- Is a right turn off the main road. Why I like this: right turns get more traffic than left turns and tenants know and value this.
- Is turnkey retail only. Why I like this: I consider the opportunity my way of learning into a new asset class.
- Has a CAP rate of 7.5% at asking price. When I run the numbers at 20% down I get worst case (with 7% vacancy) 11.4% cash-on-cash return and 19.3% return on equity. Why I like this: these numbers are about best case on my multifamily investments.
I visited the property (below) over the July 4 weekend. I learned four things that have increased my conviction.
Firstly, in the surrounding area there are at least 40 other stores. These include car dealerships, pharmacies, hardware stores, gas stations, and even a hotel. None is vacant. The area has "natural" retail traffic.
Secondly, the property had about 60 car parking spaces. No tenant is going to worry about parking being a limiting factor for their growth.
Thirdly, the building and lot were well maintained and needed no (visible) work. My proforma P&L stands.
Fourthly, behind the plaza was a large ravine leading down to a self-storage facility. That means no unexpected or noisy construction to put tenants off.
I spent about ten minutes talking to the manager (not owner) of the main tenant in the plaza. It's amazing how much people with share with you. I found out that traffic has been increasing every year and the store is profitable (and one of the owner's favorites in his franchise portfolio). The manager also confirmed that the parking lot is big enough to accommodate all the plaza's customers.
The seller has until 5 pm today (Monday) to respond to the LOI. I'm excited. And nervous. It's all easy until the first deposit check is cut!
Next up is Part II. I'll review the financing and legal parts of the deal.
For random takes on real estate investing you can follow me on Twitter @laziestlandlord