What are some lessons learned from the very first development? What factors to look out for when looking for a land to be developed? What is the state of retail sales and leasing today in a specific market, and are prices coming down? Raphael Collazo, Associate Broker at Grisanti Group Commercial Real Estate, shares his insights.
Tell us a little bit about yourself.
I'm a commercial real estate broker in Louisville, Kentucky and I've been in the business for five years. My background initially was in engineering, I was in software development for a while and got into the brokerage space in 2019. I started to buy investment properties and am now getting into the development space, so a little bit of everything.
What is happening in your area and market?
Probably similar to a lot of people around the country, transaction volume is down significantly year over year on the buy and sale side. Leasing activity has been pretty active over the last year or so. The sales side had a slowdown, but on the leasing side, there's been an uptick. I think a lot of it has to do with the fact that although we see some negative signs in the economy, with the unemployment rate ticking up, inflation is still not quite under control as of yet. For whatever reason, the consumer still is spending a lot, which is probably a bad thing long term, but in the short term, it seems to be keeping a lot of these enterprises afloat. On the retail side, it's been a very active last year or so. But, regarding investment real estate, it's been affected. I work with a lot of people who are looking to do development, especially in land acquisition, and ground-up construction, and that has been very slow over the last year or so.
Are sellers coming down on price at this point?
Some are, and a lot aren't. I think what it comes down to is the staying power. There are a lot of sellers out there that do have bank notes that are coming due. Now, the kicker is that a lot of banks are trying to work it out with the sellers, especially if they see that there's a path towards them ultimately being able to be compliant soon. Banks aren't in the business of owning real estate, so they don't want to have to get foreclosed on the property and then have to go through the whole process of getting it off their books. In most instances, if they see a path toward the seller or the owner being able to perform, they're usually going to be able to work things out with the owner. Now, there are also a lot of sellers out there that own the properties outright, and they're saying, "We'll wait around and we don't have to sell right now." There's no real urgency and so, do I think that there will be a mountain of distress? No, I don't think so, but I'm very optimistic over the next 12 to 24 months that rates are going to start coming down and transaction volume is going to spike because there's a lot of demand. It's not like people don't want to buy, it's just that we're at an impasse. And so, once the gap is bridged, I think we're going to start seeing significant volume.
I think now, it's time to get properties in contract at a lower price and a higher cap rate, and I'm sure that right before the election, interest rates will start to decrease.
All signs indicate that they are likely going to make some move in September. I think it's ultimately going to happen, and most likely it's going to be a very slight decrease, and probably the next year or so, we'll see a little bit more drop in the Fed funds rate. The interest has already started to decrease because a lot of banks are tied, they tie their rates to prime or tie their rates to the 5-year, and 10-year treasuries, and they've already been dipping a bit.
I've been getting quotes from commercial lenders where three or four months ago, rates were probably 8%. Now, we're looking at seven and a quarter, seven and a half, so there is a slight decrease happening already, but I think that's going to get more amplified over the next 12 to 24 months.
You mentioned, there's a lot of leasing activity, who is leasing nowadays?
A lot of quick service users are actively looking for space and the places that we're looking for space for are in the top places in town where everyone's looking for space. If you own an A-class asset, and particularly in retail, you're sitting pretty, the vacancy rate for retail in these top corridors is almost zero, you literally cannot find a space and when one becomes available, it goes either immediately or oftentimes, since I built relationships with brokers in town, they'll call me before something happens, and they'll say, "Tenant X may be leaving here soon, do you have anyone interested in the space?" And a lot of times, it doesn't even become available publicly.
For example, I have a deal right now that we're working on for one of my users, the space isn't even available yet. That happens, and it happens in all markets, it's not unique to our market, per se, but from a retail standpoint, I would say anywhere from 1500 to 3000 square feet, which is the sweet spot for a lot of retailers, particularly quick service and high-volume types of retailers, and are very hard to come by. And if they have a drive-through, there's nothing available right now.
As they say, you can fix a real estate investing mistake by buying something in the right location.
100% and on paths of progress as well, because five years ago maybe that area was not the greatest but now, you look back and you say, "Oh my gosh, if you would have bought five years ago in this area, you're sitting very pretty." Strategically, in my case, on the investing side and development side, the properties I've invested in the last year or so have been in the path of progress, they're not in top areas as of yet, but all the indications are pointing in that direction. And again, this is a calculated risk, but it is a risk. There could be a situation where a bomb falls there tomorrow, and now it becomes a not very attractive area, but there's a higher percentage of probability that something will take place there. That's positive.
What do you look for? Multifamily projects that are being built in the area?
You look at residents. Rooftops for retail are huge because those are the demographics that are ultimately going to be shopping at the places or eating at the places that are going to be nearby. We look a lot for different city initiatives that are pushing for certain things to happen in areas. I follow closely with different rezoning that are taking place, though, these are all publicly available. By the way, you can go to our metro market, we have the Metro council that votes on rezoning that is taking place. If you just look through a list of the ones that are being heard every two weeks, it's a treasure trove of information. In our case, we're under contract right now to purchase a property in this corridor called Logan Street, and we just recently rezoned the property to a commercial zoning and within that little strip, over the last year, there's been seven commercial rezones, and it's within a small little strip. As you can tell, that's indicating that that's where everything's swinging.
Another thing you could follow along with is traffic patterns. We looked at the proposed projects with the infrastructure bill that was passed by the National level through the Biden administration, and that trickles down to the local level and the state level. They had infrastructure projects for roadways, sidewalks and two-way conversions for streets. Two-way conversions from a business standpoint are great because they allow for slower traffic and more walkability. This particular property that we're acquiring is on a street that's being actively converted to a two-way street, it helps improve the walkability, and it's only going to benefit businesses in the long run. Those are some of the things to look out for as you're speculating on projects, this is not a stabilized asset, this is a vacant property that we put under contract at a good price. We worked with a seller to allow for us to rezone the property, which took almost a year. It's a slow process, but in the long run it's going to be, in my opinion, very beneficial because I think in the next five years, this area is going to be one of the top areas in Louisville, maybe a Nulu, it was a big area here that's very popular. I could foresee this area becoming kind of the next mini Nulu. It's a benefit.
I also wanted to touch on development because you and I are building our first ground-up development right now, it is not for the faint of heart, and there are problems regularly, and not a lot of people talk about the problems, but I think it's really important to do so because they happen with every single development. There is no easy deal out there, we just need to figure out a solution to the problems as they come. Could you tell us what you are doing and some of the challenges you've had so far?
Our development is in the same corridor that I described about this other property that we're under contract to purchase, but this property was one street over, slightly south. It has a lot of potential, it has a third of an acre of land and a very densely populated corridor. It had an existing structure on site, which we were trying to incorporate into a development, kind of a mixed-use development. Ultimately the structure didn't support what we wanted to do. Our goal is to eventually demo the structure and build a brand-new building. The premise of the development was to be a real estate development and then an operating business. The operating business was going to be a brewery that we would own and operate with a business partner of ours. And then we would have small, mini bay restaurants. Imagine those 300 square foot kitchens that you ultimately rent out to entrepreneurs, we would charge maybe $2,000-2,500 a month all in so they wouldn't pay for the water, electricity, etc. It's very easy and approachable for a lot of entrepreneurs to enter into and start their businesses. There's a huge need for that here, and I'm sure all over the country, especially here, we're a foodie city, there's Sullivan University, a large university for culinary arts, and so there's a feeder there already. It was a natural progression into the development.
Now, the challenge that we faced, first off was the rezone. It took us a year and two months to rezone the property. Even though it was a non-contentious rezone, no one really showed up to the neighborhood meetings. It was really a straightforward process but Jefferson County, the area that we are in Louisville, is notoriously difficult to get things done, but we were able to ultimately get the rezone done, and my business partner and I put in some capital, and raised a little bit of money to round out the capital stack so that we could close in the property cash. Since then, we've been interacting with different banks, and again, this is a brand-new venture, so we're going to be doing an SBA loan, we can't go conventional. No bank would be able to lend to us for this size of development, it's going to be roughly $3 million.
On the development side, we had three business partners. I'm a commercial broker, my other business partner is a real estate partner, and then another one of our business partners was the brewer. As of this morning, we got an email from him saying he's no longer involved in the development partly due to the fact of the lead time to getting it opened, I think it's going to take about a year and a half to be up and running. It's a lot to ask for someone to hold off for that long to be able to commit to this type of project, but it's ultimately something we were disappointed because that's a big piece of the development. That was a big piece of what we're trying to do and we communicated with the investors that we've had conversations with early on, presenting this particular project, and luckily, all the investors that we've raised money for believe in us. And they said, "Look, guys, we have faith in you. For now, we'll keep our investment with you, we trust you to try to find a new business partner, and if, for whatever reason, that doesn't work, there may be an opportunity for us to then pivot and maybe do a different type of development on-site." I think it just goes to show that you could put in a year and a half into something, and then you hit a huge wrench that then you just have to find a way to pivot and find a new approach to what you are doing. And I said this to my business partner today, if it were easy, everyone would do it. This is not for the faint of heart, so I think that it's just a testament to the fact that everything looks good on a spreadsheet, but until you're actually in it, you don't know what you're talking about.
You said that the city was very difficult to deal with, what were the specific difficulties, and was it just time or non-responsiveness?
It was multiple reasons, I think a big piece is that redundancy in certain things of the process. There are several processes within the broader process of receiving the rezone that I think are somewhat redundant. I also think they're just understaffed. There are a lot of cases that are being submitted for rezone, and review, and ultimately, not everyone can service them, and so there's the different cadence of the process. And even though it's a slam dunk deal like in our case, the entire corridor is being rezoned, there's already a precedent set, we're not asking for anything that's out of the ordinary. It would have been a slam dunk home run deal but we had to wait our turn in that respect.
Part of it is, in any city there's going to be a form of nimbyism, which is not in my backyard. There are pockets of the city where any proposed development is objected to and when things get pushed forward, or try to get pushed forward, they say, "Okay, we'll allow that to happen" but then they try to put on all these different restrictions or requirements that make the development unattainable. What ends up happening is that these plots of land don't get developed, or even worse, a decrepit, vacant building sits there for decades. And then you're no closer to getting that eyesore taken care of than you were 10, 15, 20 years ago. I think it's a multitude of different reasons as to why, but I would say those are probably the three most common. And the two that you can control are the process itself and then staffing.
What was the reasoning for the brewer, and where would the brewer go because he still has to wait a year and a half no matter what?
He's a young father and has obligations outside of that, his wife's a nurse so he would have been able to sustain himself, per se, but it is a lot to ask for someone to say, "Look, stick around for a year and a half and at that moment in time, then you'll have a salary." And part of our arrangement with them was to take a piece of ownership that would vest over time. We wanted to make it as attractive as possible for the individual, but at some point as well, it comes down to the fact, 1) can you wait? 2) is the vision aligned? Because I'm not a brewer by nature, I don't have any experience in that space. I know the economics of the brewing industry, I've done a ton of research, so I think it's a very attractive space that could potentially be lucrative, but I don't claim to be an expert at any vertical within that space. The personality types of someone who's in the real estate space versus someone who is in the brewing space and approaches it as more of a craft, can sometimes not align. There were times when we had to talk through things and say, "I understand that this would be a great way to approach this process, but maybe approaching it from a more economically focused way would be of benefit."
In pre-revenue, the logic was to not brew anything until we were closer to opening because then we would build anticipation. But for me, I'm more of the lean startup model, where it's like, let's get a product rolling and iterate as we go, and maybe we can start generating some revenue, and eventually, we'll refine it to a point where it becomes a lot more finalized product by the time we get to open. That was a point we were talking about, and I'm not saying that's what caused it to not work, but again, different personalities, different visions, it's a people business. It's not just black and white as everyone makes it seem. In a vacuum, it would be perfect, but you have all these different other things at play that you have to contend with.
Managing personalities, goals, and they have their family things going, it's a lot of different things. There are some co-founder questionnaires out there in the tech space that are phenomenally helpful. And they go over questions like, when would it be enough for you? What would be a circumstance that would make you want to quit? What is important to you? That helps align things and going through the hard questions first. It's very easy to get excited about something, but it's super important to go over the difficult questions because the difficult moments will arrive very soon.
Everyone's different. If you have a different way of viewing the world, or you have a different way of approaching that process, it's not right or wrong. But to your point, it's better to know now or early on than it is when you're in the thick of it and all of a sudden, things are starting to fall apart around you, and you're supposed to be in the foxhole and they decided that this isn't for them. That's a problem.
Is there anything else that you think is important for our audience to know about either the market or development?
For development, just understanding that although it sounds fun and it sounds exciting and you're going to be bringing something to fruition or bringing something to life, it is not for the faint of heart, but I wouldn't change it. I think this is something that I am excited about, it’s probably going to be hard the next year or two or three, or however long it takes for us to get things done. And maybe over time, I'm going to take on more development projects, and more so, it's just choosing your heart. If this is the heart that you want, then do it. When you're going through the fire, put a smile on and just get through it because at the end of the day, hopefully, you'll come out the other side a better person.
Raphael Collazo
raphael@grisantigroup.com
Grisanti Group Commercial Real Estate