Why You Shouldn’t Just Focus on Cap Rates in Real Estate Deals

(Transcribed by TurboScribe.ai. Go Unlimited to remove this message.)

What is up, and welcome back to another amazing episode of how to invest in commercial real estate. Coming to you from Jinx, Oklahoma. That was cute.

You like that? Yeah. Coming to you from Jinx, Oklahoma. You should commentate the Metro games this year.

Uh, no. No? You can become the new voice of Metro High School. I mean, I would say the F word or something.

They're like, hey, Joel, you got to leave. Your son's off the team. Timmy gets knocked the F out of you.

Yeah. Whoa. Okay.

Anyway, back to real estate. So we have a lot going on. August, I think technically August is the slowest month in commercial real estate out of the 12 months.

Not for us, it isn't. Well, yeah. Unfortunately, fortunately, unfortunately, whatever.

Anyway, we slowed down a little bit compared to June, July, May, April, and March. We are a lot slower. So we closed the Dawson Petromax deal.

We closed our Florescent retail deal. We closed our Amarillo retail deal. And at the end of this month, we are now closing on the Houston retail deal, which is our biggest deal of the date.

It's almost Joel's biggest deal of the date. Almost. No, not even close.

What are you talking? This is 14.2. The biggest one. Yep. It's like 16 and a half.

So we're getting close. Minus Iconic. But yeah.

I mean, yeah. Minus the thing we're building and it's not done yet. I mean, it could go.

It could be the biggest by an extra 10% because you could get over budget. Can you stay focused? I am focused. You're the one taking a shit on my numbers, man.

All right. So I don't think August is slowing down because yeah, 14.2 by the end of this month. By the time this episode airs, it might be full.

But as of right now, there is a sliver of equity left. It was a big equity raise and we've knocked out all of it, but about the last, what, few percent? Yeah. Like 3% or so.

Yeah. You have to be accredited though. Have to be accredited.

We've unfortunately had to kick out several hundred thousand dollars worth of commitments. I feel bad for this one guy. He signs up.

I feel like exclusively for deals that you have to be accredited on. And it's not like we're, I mean, I guess we are picking which ones you have to be accredited on, but this one we advertised. We advertised for a long time.

It was a massive equity raise. Is our biggest equity raise to date. That's good.

Yeah. Yeah, it is. Brought on a massive new partner, super excited about cultivating that relationship on the LP side.

All in all, we've worked really hard on this deal. We're super excited to go in and take it over anyway. Yeah.

If you're seeing this, go check it out. There may be a last $50,000 slot you may be able to scoop up. Otherwise, for those of you who have gotten your commitments in, we will close on this thing August 28th.

Yeah. So seriously doubt we'll pay a third quarter distribution, but Q4, we'll pay maybe a slightly prorated Q3. That'd be nice.

Yeah. Other news. We signed a letter of intent to sell our New Jersey Kitty Academy.

We've been waiting a long time for that. That has been a tough investment for us. It was a two property investment.

The first half went really well. We exceeded expectation, but the New Jersey one, we have not exceeded expectation. The operator for this Kitty Academy just never could get the enrollment up.

And with interest rates spiking, it really put downward pressure on the sale price. So we're happy though, because I think we're going to be able to get all the investors their money back without losing any money, maybe even give them a modest return. I don't know.

You may know what that is. Modest. It's 9% or so, right? I think it's more than that.

I think it's like 10 or 11. Oh, wow. But even better than I thought.

Yeah. It's not the best news, but I mean, beating... Not bad for our worst deal. Not bad.

Yeah, that's going to be a good one. And it was really because it was combined with the other one. Obviously, we don't have to sell.

We could hold out forever and wait until the back stock of inventory clears out, interest rates lower, but in an effort to kind of end that investment, we did well in the first one. Now we're kind of being punitively punished the longer we hold on to that second one. So we're getting rid of that.

But yeah, we'll deliver a good return. Beating 30-year average of the S&P 500 is a good return, right? People don't even do retirement calculators at 11% because they're so modest. So not bad.

We closed or about to close on the Salton Go in Princeton. Was it Princeton or Owasso? Well, we just signed the LOI on the one in Owasso. But yeah, the one in Princeton, it may have been the Chipotle.

I need to double check on that. So we're starting to see some activity and some movement and with rates starting to come down 10 years down 50 bips over the last few weeks, hopefully we start selling the ones that we want to sell and get that money to return to the investors because we got more deals that we need them to invest in. And so it's kind of turning that equity and it's good for us, but it's good for them.

The faster we can turn their equity and give them returns, the more they're going to make. There's a lot of end of year purchases in the single tenant absolute net lease space. Just looking for that last bit of depreciation you can shove in the 2024 calendar year.

So I think we'll get a big spike on that. Obviously a big chunk of the US thinks there's going to be a rate cut in September. They've kind of foreshadowed that for a while.

Will we get one? How big will it be? What will that do to everything? So yeah, there's plenty of time left in the year. We're taping. It's Wednesday.

When is the inflation numbers out? Tomorrow? I thought they came out yesterday. I thought they were down to 2.9%. Okay. I'll have to look.

Yeah. I could be wrong, but I thought I saw that. That's better than the jobs report.

I thought I saw that. Or maybe today. Maybe I saw that today.

Maybe I can look it up while we're talking. Anyway. A lot going on.

We are starting to see some activity on the sales side, so we're excited about that. Developments under construction are going good. I know we just finished the Starbucks multi-tenant retail deal in Marine Creek.

I know we just finished up Calloway's, the nursery we did in Houston. They're about to open. Starbucks, like I mentioned, in Marine Creek is about to open.

We've got the donut shop and the few other tenants in that strip center. We've got Calloway for sale already, don't we? Calloway's is for sale. Yeah.

We just switched to a national broker. We gave a local broker who kind of helped us in the beginning a shot to sell it, but now that Calloway's is opening, we went ahead and launched that to a national group. What else? We've got the two TLEs in construction, the Burleson and the Grand Prairie.

Both of those are going good. We ... Yeah. Everything's kind of moving along.

So topic for today. Guys, what is it? Well, you know, we actually talked about this a little bit on the last episode, but we're going to talk about why you can look at two properties. One, for our example today, we've got one at a nine cap and one at a 7.25 cap, and they're similar properties, but for some reason they're for sale for different prices, and we're going to talk about that.

Different cap rates. Different cap rates. Sorry.

Yeah. And that's right, guys. And this is the whole thing.

Like I said last week, this is what we do is we try to find properties that are at one cap rate and properties at another cap rate. What is the difference, and how do we get that value? Because if you buy at a nine and you sell at a nine, that's okay, but if you can buy at a nine and sell at an eight cap, then your returns really go through the roof. And I kind of contrasted buying used cars and saying you can find ... Like I just bought a Ford Explorer for one of my sons, and I'm paying one number, but literally I can find it for $8,000 more in another city, and it's the exact same car with the exact same miles.

And you just ask yourself, why is that? I don't know exactly why that is all the time, but that's how real estate works. It's not a perfect market. And so when you're in residential real estate, you drive neighborhoods until you know that neighborhood.

And so then when a house comes on the market, that's an anomaly that you can take advantage of. You're going to know it because you've seen a hundred houses in that neighborhood. It's like, well, this one's 10% less.

That's what we're going to show you today with these two. So we have one ... Let's start with the seven and a quarter cap, Brian. Let's talk about some of the tenants that you can expect to find in the seven and a quarter cap.

Okay. So this particular property is in St. Louis, outside of St. Louis. And the tenants are ... Like North St. Louis, so not like the hottest area, but it's not a bad area.

Right. So there's a subway, there's a wellness center, there's an H&R block, there's a nail salon, and there's a city. Okay.

So all what we would call regional to local tenants. No national credit, no big time guarantees. Okay, great.

Talk to us about the demographics a little bit of the seven and a quarter cap. Okay. So I'm going to give you the five mile number.

Population is 250,000 approximately. And a five mile radius. That's really ... Think about it, guys.

That's like a 10 mile diameter surrounding the property. You have a quarter million people, which is pretty decent. The average household income in that five mile radius is $60,000.

Medium home value is about $100,000. So those actually aren't spectacular. 60,000 isn't terrible.

You know, in the poor areas, the average household income will be roughly 45,000. So when you get into the 60, 65, that's solid. Really good demographics where you're really strong is going to be 80,000 to 100,000 or higher on average household income.

A couple of other things. Okay. It's 90% occupied and it's on a hard corner with 18,000 vehicles per day on one road and 13,000 on the other.

So about 21,000, 31,000. Yeah. 18 and 13.

13. So about 31,000. Yeah.

What's the NOI? 400,000. Okay. Okay.

So that's a seven and a quarter cap, which today with rates where they are, you're kind of even leverage. You might get a rate in the seven range. You're still going to make money with the center.

But it's a class B center, average local tenants. Where? Where is this? In North St. Louis. North St. Louis.

Okay. All right. So we've got another one that Braden's got and it's in a suburb of Detroit.

Aggressively priced. Yeah. I mean, just.

7.25. I, I, it seems like it should be more full. It seems like the tenants should have better credit for that pricing. It seems like it should be in a better part of St. Louis.

Yeah. Yeah. I initially backed the napkin, not understanding the pricing behind that one.

We did. I'll just tell everybody, we did not cherry pick this. All we did to get these two properties was about 10 minutes before we got up here.

We opened up Crexie and we did a search for retail centers. B class retail centers around $5 million that were seven cap to nine cap. And then we just saw what came up and then we just picked two that were similar.

So Braden, this one's about 5 million. What's the price on this one? 5 million. 5 million.

Okay. 5 million. And this is in a decent suburb of Detroit.

Yup. Not, maybe not a great area, but not a bad area. Very similar.

And that the other one was a suburb of St. Louis. Okay. So hit us with some of the tenants.

Yeah. Immediately right off the bat, you have O'Reilly and Dollar General. Decent.

Both of those are decent. You have a 13,000 square foot Biomap Plasma Center. I'd be interested to see the credit profile behind that.

Yeah. I'm not sure what the credit is on Biomap. But in my experience, those plasma centers tend to do fairly well.

Yeah. Okay. Who else? T-Mobile, a bunch of 1,500 square foot shop space tenants.

Looks like two or three local tenants. You have a city trend, so you've got some credit there. Yeah.

The Dollar Tree's good. O'Reilly's is decent. So I would say these tenants match up really well to the tenants that are in the seven and a quarter cap center.

Okay. Let me go to the demographics page. I think it's toward the end.

No. I don't have demos in mind, unfortunately. Yeah.

We don't have the demos on this. It says it's near the Dearborn Airport, six miles from the Detroit Metro Airport, four miles away from a hospital. We already did this.

I mean, it has, I think it was 300,000 people in a five mile radius. Right. Household income was like 75,000 versus 65,000.

Which is better. More homes, higher household income. Hard corner at 55,000 cars a day.

I'm talking myself into this one. We're already looking at this. So this had 31,000 cars.

This has over 50,000 cars. The demos are a little bit better here, population wise and average household income wise. Yeah.

And so what is the cap rate, just the ask cap rate on this? It's 88% occupied. This is 90, so virtually the same. Yeah.

So you've got a little bit of room to lease it up there, but they're asking a nine cap for this. Again, outside of Detroit, it's in Inkster. Near Dearborn, which is pretty nice.

You've got a little bit of room to lease up. I mean, based on this, I would think that the parking lot and roof are trash. Yeah, maybe.

This has a lot of gross leases that I feel like you could convert over to triple nets, get some upside there. You're at half of, I mean, a third of replacement costs. You could buy this thing for the asking price at $78 a square foot.

So not sure the last time you quoted retail real estate. So let's just say that this is worth a nine. Now, let's just say that this is worth an eight.

After you convert the leases and do some of the CapEx, but you can buy it at a nine. And that's saying this is at seven and a quarter. This may sell at seven and a half.

I don't know. But what's the NOI on this? 486. 486.

So if you can get a point, one point of cap rate on 486, what does that do for you? So if I put 486 on an eight cap, that's $6,075,000. But if I buy it at a nine, 486, that's $600,000. $600,000, guys, in potential value.

Because this center is probably every bit as desirable as this center. And this center is probably going to sell sub-eight cap. And you can buy this one at who knows what.

It's asking a nine. You can maybe buy it at a nine and a quarter, nine and a half. And so I think the market for both of these is probably closer to an eight cap.

I mean, I don't know. I don't know much about these markets. Where was that one again? St. Louis.

I mean, St. Louis. Yeah. I think neighborhood retail in St. Louis.

I mean, we've bought several centers in St. Louis. I think you're seven and a quarter cap on maybe the good side of St. Louis to nine and a half, ten cap on some of the rougher sides of St. Louis. So you have a lot of disparity there.

I don't think this is priced accordingly to where it's located in St. Louis. Well, to the deal, it's just not. The only point we're going through this exercise to show you guys that the deals are out there and they're right in front of you.

And you can't just focus on cap rate. No, there's a lot you got to focus on. But we were just trying to show you that here's two properties that are virtually identical in NOI, virtually identical in cap rate, purchase price, demographics, and kind of where they are in relation to a major metro like Detroit and St. Louis and how differently they're priced.

And so in that difference is where you can make money if you know what you're looking for. If you look at hundreds of deals, you're going to find one of these at a nine cap that maybe should be an eight or an eight and a half. And you want to stay away from this that's a seven and a quarter that really should be an eight and a half.

And so if you can learn that arbitrage right there, then you have a chance to be really successful in buying commercial real estate deals. And you get that education by looking at a ton of deals because the deal of the decade jumps out at you when you look at hundreds of deals because they all look the same, they all look the same, and then pretty soon you're going to run across one that looks the same as the other hundreds you looked at, only it's priced lower with a higher cap rate. And that's the ones you want to jump on.

Or at least dig into them to find out, is there anything I'm missing? Because sometimes you'll dig into it and it'll be like, well, it's a leasehold interest, it's on a ground lease or something and there's a reason. But if you dig and you can't find a reason and everything starts checking out, those are the ones we just keep going down the path until we ended up closing on it. Just must be a motivated seller, right? Could be, yeah, or they bought really well, they've owned it for 20 years, the parents died and the kids don't want it anymore.

All of these factors are at play when people try to decide what they're going to take for the asset. Any other comments before we wrap it up? Yeah, I mean, I think the big thing for me on this is so many people when you talk to them about commercial real estate, I mean, we have a tendency to do this sometimes, to say, yeah, I buy eight cap deals just because a lot of the times we end up buying eight cap deals. It doesn't mean that you can't buy this seven cap deal and have something work.

I think it's too much of an easy laziness in your underwriting instead of just looking at the deal and saying, hey, I'm looking for $5 million deals. Where does $5 million give me the most bang for my buck? And trying to look through it from that perspective. Yeah, you can buy this deal right now and you can not negotiate on the price, you can pay a seven and a quarter cap, you can get a 675 on the rate and you can make money as we showed you last week.

You will make money on this, but you'll make way more money on this, maybe potentially double the percent return on that. And so they both make money, but we're just showing you how to maximize your profits for your effort. And for all the brokers out there watching, if I'm a broker and I have two sellers, this to me is like, I could sell it if I get a perfect price.

If somebody wants to pay me the moon, sure. That's what I see and hear after looking at that OM and the pricing. When I see this, I'm like, okay, this is price to move.

Nobody's going to come in and low ball the crap out of this. I feel like people are going to write an offer that starts with a five, it's listed at five, four. I mean, good package put together here.

So brokers, I think now more than ever, the pricing on the face value of the listing matters. That's going to get clicks and it's going to get attention. But anyway, that is the show for today.

There's deals out there. Don't just pay attention to the cap rate. And if you haven't already, make sure to check out that latest Houston offering on our website.

We still have a little bit of room and we will catch you next week. Next time, guys. Thank you.

Thanks.

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