Unlocking Wealth with Commercial Real Estate: A Guide to Appreciating Assets

Join Braden Cheek, Brian Duck and Joel Thompson of The Criterion Fund for Episode 143 of 'How to Invest in Commercial Real Estate,' where we discuss the quickest way to increase wealth in commercial real estate - strategic rent growth.

This is good quality breaker. Look at the bones of that center. Good, good bones. You ever hear that? I have heard that not necessarily in a shopping center, but I don't think I've heard anybody say it quite like that, but it's weird. Creepy. All right. What is up and welcome back to how to invest in commercial real estate. Yeah. There you go. Brian today. Jeez. All right. We have a lot going on, man. We've been busy. Like, what, what do we pay this guy for? I don't know if we pay him yet. He's not paying me. That's why I don't know what's going on. If you start paying me, I don't pay attention. I'll show up, do some things. Hey, good news is uh like not most, all of our tax returns are done. I think we're just missing like one or two and they're, they're not our fault. They're third party vendors or third party partners. It's other people's fault. So if it's your fault, if it's your fault and you're hearing this, then shame on you. But anyway, a lot faster than last year. So we're excited about that. Um What else is going on. Uh, Brian and I, because Joel's too busy, um, Brian and I went to Muskogee this morning.

I was too busy trying to support my daughter at her first track meet. Ever. Don't, don't guilt us. I didn't get to go. I drove my personal car. Yeah. That looked like an interesting deal though. Yeah, it could be cool. It could be cool. I mean, Muskogee, it's a big deal. Big property. How much, how many square feet would we be developing? You remember? Lots looked like 200,000 or something? A couple 100,000 or so good corner in Muskogee. Lots of big traffic counts. Yeah. So we up and coming area. Yeah. And it's just, it's, it's bogus. Right? Because I didn't have the earliest of nights last night and, and we have to be in Muskogee at, at 10. So it's a bit of a drive and then we get there and it's like, oh, yeah, we're gonna be an hour and a half late. So we sat in Starbucks for an hour and a half. Yeah, for a 10 minute meeting outside in a field. That's real estate development. Guys. Thrilling. It's interesting. They didn't tell you till they got there. They're gonna be late. Yeah, like you're driving from four hours away, you knew you were gonna be an hour and a half late when I could have still been in my bed. But now I'm really glad I didn't go anyway. Um we have several offerings going on.

I know we just closed the Burleson learning experience. Um So we're gonna get that going super excited about that. We have the Petra Max offering that is currently opening on the website. And then we have another, I say another, but we've been working on several, I think it's the first shopping center we've launched in a while which I'm pumped about. It's in contract. It's our, I mean it might have been more than a year, right? So it's been a minute actually two shopping centers. What are we doing? Sweet man. I want to get some cash flow up in here. People like shopping centers if you like shopping centers and you want to invest in shopping centers hit us up, we got them and it kinda goes to the theme today. We're talking about uh appreciation and commercial real estate and shopping centers are a great example of how easy it can be to just buy hold and get rich. Yeah. And so why do shopping centers appreciate? Yeah, so I can see I can I can understand where homes appreciate along with inflation but the price of a shopping center, why does it appreciate?

Well, real quick, why does uh why do homes appreciate you? There's it's just general inflation, right? But but why, why does that affect the home price? I just want to make sure we we give them the right information. It's not just because supply and demand. Yeah, somewhat. Um it's supply and demand and that cost of goods are going up, cost of development is going up and, and the population grows every year. You know, so many kids graduate from college, uh graduate from high school, they're looking for places to live and, and so they families want to buy houses and so they can either buy a new house or pay someone to build them a new house or they have to buy somebody else's house. And so the cost of building a new house is always going up. And so that drives the price of already existing houses up. And of course, there's a lot of other factors that go into that like demand in an area, more people moving into a certain area versus leaving an area, people, everybody's leaving an area, your house might go down in value. But that's pretty rare. So well, since I don't care about houses, let's move on. I just edit all that out. So the shopping centers like let's just talk about an appraisal of shopping center.

I think so many people when, when they think about commercial real estate, they're, they're looking at the commercial real estate and they're like, oh man, that's nice metal siding or this is good quality brick or look at the bones of that center. Good, good bones. You ever hear that? I have heard that not necessarily in a shopping center, but I don't think I've heard anybody say it quite like that but creep. Wow. Wow, that's great guys. But anyway, it is nothing really, nothing. Not much to do with the inherent real estate, right? Very less because we're buying these things. We're, we're buying streams of cash flow and they're giving us a piece of real estate for free kind of attached with it is, is the way I look at it. So it sounds like that stream of income needs to go up then if the value of the shop. Yeah, thank you. Thank you. Right. So since we don't care about the real estate, it's not about the the cost necessarily, even though that's an indicator we may look at if we're buying a stream of cash flow, right? What would make the value of that? What would make the stream of cash flow worth more is if the stream of cash was bigger, if it was a larger number, like if we, if we bought it, we had a half a million dollar a year, no I or or kind of general rough profitability before the debt service.

And at, at the end of five years of owning that we could get it up to $600,000 of no I or rough profitability that $600,000 should just on a very basic level, be worth more than $500,000 right? So again, we're not gonna focus on the inherent real estate and I think that's an, uh, uh, a beginner's trap that a lot of people fall into is, like, appreciation on real estate. I need to study the, the cost of construction don't focus on that for now. Right. So, how do we increase our, no, I, or our kind of profitability for the center. How do we do that? Or, or anything? And it could be industrial, it could be multifamily, it could be, um, retail. Uh, right. How do we increase that in a lot? Well, one way that doesn't seem like it would work too well is to cut costs. Right. Right. But your costs are kind of given. Right. I mean, yeah, costs are typically fixed. You can do a little bit on the cost side, uh, especially with multifamily because it is so cost uh driven. You have, you have employees, you have salaries. Uh, so, you know, multifamily and office, I would say there's a big opportunity for cost cutting, especially if it's been mismanaged or if there was high vacancy or a lot of deferred maintenance, you can do stuff on the utilities, maybe, uh, you know, cut down on your water use or your electric use with led S or something.

So you can do some things. All those costs are born on the owner. But in, in, you know, retail typically each tenant is taking care of their own utilities and they're kind of managing their own space. And so you don't really have the inherent cost to cut in a retail deal or even an industrial deal. Uh And so that's why you really want to focus on the income and the income comes from the rent, you charge your tenants. Yes. So when we are looking at a piece of real estate the first and almost most important piece of paper, and it's typically one paper unless it's a bigger center is the rent roll, right? And the rent roll just tells you the name of the tenant, how much square footage they have, how long they've been there, the term of their lease when it's expiring, which is very important information. Um The rent, maybe when the next rent increases are, it'll tell you if it's absolute triple net or gross or some sort of modification and everything like that. And, and that's a quick evaluator. You can typically get an no I straight straight off of that, especially if it's an absolute triple net deal. Um And we're looking at that and we're, and we're saying, ok, this tenant looks like it's way under market, you know, uh uh they have, they lease 2400 square feet and they're paying $10 per square foot every other 2400 square feet in this square foot center in, in this earth, jeez man, every other 2400 square foot suite in that center are, are paying $15 per square foot.

Why is this one paying 10 I bet I could get them under up to 15. It's obviously a, a market value for that size. So we're looking at that and when we're underwriting it, that's what we're doing. We're, we're putting in the net operating income for year one in income and expenses, right. That gives us the net operating income. We're saying, how, how can we increase that net operating income? And where is it actually coming from? We're not just picking a number out of the sky, right? We're we're looking in there and saying, ok, these tenants are, are under market. If they were to leave and try to find new space, it may not be available, it it may be scarce, it may be more expensive. They may have to uproot their business. There's a million reasons, right? But that's, that's how you do. It is uh lease renewals and increasing their rent. So uh so whenever you wanna increase uh rent, what's uh I mean, what's a good rule of thumb? I mean, inflation type numbers or yeah, it depends on a couple of factors. When I'm uh negotiating uh rent increases with tenants. I'm asking myself, are they at a market rent?

So let's say that they're not at a market rent. Let's say they're like your example. There are $10 but I think the market is $15. Now, I probably can't get away with 50% increase in rent in one year. That that would be really, really tough for the tenant to absorb. But what I am gonna do over the next five years, six years is I'm gonna try to move that $10 to $15. So that's pretty easy. And, and how say, well, how do you know what, what the market is? Well, you either have other similar spaces in your center you can go off of, but also you want to go around and call on vacancies or ask other tenants in the vicinity, similar size type units. What are you paying or what are you asking for that vacant space? So you can pretty quickly get what the market rent is. But let's say they're, they're at market, let's say you've called and the market's 15 and they're at 15. So then what do you do? And that's where I would, I would try to use an inflationary argument that, that, hey, uh inflation was, you know, 6% this year or 4% this year. And so I'm gonna try to get something close to inflation. I may not be able to, if they're already at market, I may not be able to get them up 6% every single year.

But I, I might be able to go for a 3% a year increase. Have them try to sign a five year lease with 3% increases, three percent annual increases in that example. Yeah, I would, I would try to get them to market and then once they're at market do 3% or some sort of inflationary uh annual increase from there. But the first priority is getting them to market and that's the biggest value add. You know, you ever, you always hear people talking about value add and a lot of people think it's a remodel, but in my opinion, that's way too much work. Sometimes. I mean, sometimes the rent increases have, you have to do some sort of remodel or, or um, tenant improvement or um, a new appliance package in multifamily or whatever it is to command the rent increase. Sometimes you don't have to, a lot of the times you don't have to because you just have somebody who's owned this piece of real estate for 20 or 30 years. It was a good, rough profi profitability when they bought it. You know, they've had it forever. So they're just not aggressive with it. So you end up with a bunch of tenants who are just really below market rents.

Well, if, if we just take a half a million dollar, no, I, and we increase that by 3% every single year for five years and five years is good measurable. Hold period for investors and lenders. That's a very common metric. We end up with an No I somewhere around like 562 I think. So, let's just say we bought that house half a million dollar, no I or income stream at an 8% market cap rate, maybe higher, maybe lower. It's irrelevant to the point I'm trying to prove. But now we sell the 562 on that same 8% cap rate. We made $750,000 right. We still probably made a 10% cash on cash return while we held it. So we have a 10% return there. We made um it was 6 million when we bought it. So we probably put a million two down. So you made fit, you know, 10% a year in appreciation. So 10% from cash flow, 10% from appreciation. And I bet your principal pay down just from paying your mortgage is another 7 to 10% a year. So you can just see how real estate is literally trying to throw cash at you from every single, every single facet and especially in high inflationary times like this, when everything is getting more expensive, you own something that you can now charge a lot more for because nobody like there's a lot less retail shopping centers being built.

I don't know if you've noticed that there's a lot less of everything being built. So owning assets now you can see why owning assets that you can increase the rent on. I think you said that is it can just build wealth so fast. Well, yeah, Joel, you were telling us an example of a property uh that precision has in um in Las Vegas. Yeah, that was a prime example. We've been able to increase the rent, uh a lot. The rents were way below market and you know, it's in Vegas. I don't go to Vegas very often and I definitely don't go to that property very often. We have it managed by another company. So there's not any work that has to be done, but uh just by increasing the rent and uh the market improving, that property has almost doubled in value in 67 years. Uh and ju just by, it's out there in Vegas, I'm just owning it. It's doubling in value and think about it. It's not, we're not doubling our equity, we're doubling the value of the property. So we only put down, you know, 20% on that property. So now if I double the value I've made five times my money. Uh And so that's how powerful it is. It's automatic wealth generation just by properties going up in value, by just by increasing the rent.

And I think people think there's more skill to that than there really is. And, and staying on that example, right? Like the guy that you bought it from, bought it for half of what you paid for it, right? Like it doubled, why he owned it, right? So it's not like we're the most special, brilliant real estate savants ever, right? It's, it's a normal process to like shit gets more expensive just by owning it because the, the, the, the value of the, the services, the rent goes up. Yeah, and you can do, you can look at history and, and you know, ask, ok, what was this, what did this building cost 10 years ago? What does it cost today? What was it? 10 years before that? And you can look at how, how much it goes up in value and you know what's great about commercial real, as we've said is you're not making the payment, the tenants are making the payments. And then with regards to re res uh retail, you're not managing it, you have a, a company managing it and the tenants are paying for that. So it really is an automatic wealth generator. Uh just by owning assets that, that you can have managed and that go up in value.

I wanna have as many as I can. Yeah. So then it's just a function of how much, how many assets can you buy and hold, uh, the, the richer you get over time, but most people are afraid or don't have the education. So they don't buy any assets at all. Uh they, they say their house is an asset and it is, but they're the ones making the payment for that asset and they're the ones paying for the upkeep of that asset. My retail, I don't make the payment on the retail. I don't pay for the upkeep, right? The tenants pay II I bill them for all of it and, and they pay the taxes, they pay the insurance, they pay the utilities. It just sits over there and I get, somebody sends me a check or sends me a statement and tells me how well they're managing. And so I just don't know another asset class that is, that is as strong and proven as commercial real estate and going up in value over time. Good. That's good. All right. Buy assets. Let's go. Let's go. All right. Well, I guess that's it. We'll see you guys next time on how to invest in commercial real estate. Right.