By Christopher Miller, MBA
Specialized Wealth Management
During nearly 20 years in the investment real estate business, and while completing a graduate degree emphasizing real estate finance, I have learned a lot about the types of rental real estate that I prefer. Every day, I try to share this knowledge with my clients to help them grow their real estate portfolio while maintaining their cash flow potential. I recently wrote a three-part series about Properties that I Don’t Like. This month, I thought an appropriate topic would be a review of Properties that I Do Like.
When Buying Properties, What I Look For
When evaluating potential real estate investments, the first thing that I look for is a relatively low expense structure. High expenses, I have found, are what make properties like multi-tenant office and retail properties unattractive to smaller investors. These high expenses come in the forms of high tenant turnover costs; known as “tenant improvements.” While apartments have tenant turnover costs; they are relatively low in comparison and usually involve a coat of paint and some new carpet. Office and multi-tenant retail space turnovers are often more involved – imagine if putting a new tenant in your property meant turning two bedrooms into three, and moving the kitchen to the other side of the unit.
The second thing I’ll look for when evaluating a property is its geographic location. I prefer growing metropolitan areas because I feel that a growing pool of potential renters is good for apartment owners, and a growing pool of shoppers can help drive retail rents, (and therefore values), higher.
Net Leased, Single Tenant, Retail
I like single-tenant, net-leased retail properties that have credit tenants in place for long-term leases. There is a lot of real estate lingo in that sentence, so I will explain it a bit:
I prefer single-tenant “standalone” properties because they, as landlords, allow us to focus on finding good, solid tenants without spending time and resources filling smaller spaces with pet or frozen yogurt shops.
A net lease refers to an arrangement where a tenant will pay most, and sometimes all, of the landlord’s expenses related to a building. Companies like Walgreens are usually much larger than their landlords, so they prefer to have more control of the properties they occupy. As a result, they will sign leases where they agree to pay their rent net of expenses; that is, Walgreens will pay their utilities, pay for casualty insurance and even pay property taxes before they pay rent to their landlord. I like this structure because it insulates landlords from the threat of rising expenses. Electricity, insurance, property tax rates are way up? That’s all the tenant’s problem under a net lease.
A credit tenant is a large company that has publicly rated debt. This is important because it restricts the ability of a tenant to escape their lease obligations. For example; Walgreens’ parent company is rated BBB by Standard & Poor’s. Much like an individual’s credit score, this credit rating controls the company’s ability to borrow money and the interest rate charged. Let’s say that Walgreens pays $355,000 per year of annual rent at a property, and has signed a lease promising to pay that amount for 20 more years. Even if Walgreens moves out of that store, they will need to continue paying rent – a default on that lease would cost them much more than that in the form of a reduced credit rating restricting their borrowing ability.
Long term leases are fairly self-explanatory – the longer the lease term, the longer the amount of time that the landlord can go without worrying about renewing the lease. (Perhaps that time will come long after he has sold to another landlord.)
Apartments in Growing Metropolitan Areas
Apartments are an asset class that we use a lot because most of our investors are already familiar with how they work. Everyone needs somewhere to live; if we buy apartments that are located where there is demand for them, then we should have a good chance of seeing income and value growth in the future.
To me, buying apartments in growing metropolitan areas seems like common sense, but I see people considering properties in shrinking markets all the time. The United States is adding (net – after deaths) one new person every 12 seconds, or 2.5 million people per year. This means that we are building the equivalent of the San Antonio, TX metropolitan area every year to give all these new residents places to live, eat, work and shop. These new residents aren’t spreading out evenly across the country – they are concentrating in certain areas. Some of these areas are additionally experiencing high rates of migration from other parts of the country. Why not give ourselves the best chance to see growing rents and property values by selecting investments in these areas?
My practice in Tax-Advantaged Investments focuses on helping my clients keep more of what they earn by reducing their tax burdens. By focusing on real estate with comparatively lower expenses, we’re doing the same thing – generating more spendable income. If you have any questions, my toll-free number is (877) 313-1868.
Christopher Miller is a Managing Director with Specialized Wealth Management and specializes in tax-advantaged investments including 1031 replacement properties. Chris’ real estate experience includes work in commercial appraisal, in institutional acquisitions for a national real estate syndicator and as an advisor helping clients through over three hundred 1031 Exchanges. Chris has been featured as an expert in several industry publications and on television and earned an undergraduate business degree and an MBA emphasizing Real Estate Finance from the University of Southern California. Chris began his real estate career in 1998, began working in the partial interest industry in 2001 and has been a broker advising clients since 2003. Call him toll-free at (877) 313 – 1868.