What are some things you need to keep in mind when leasing your property? Why should you put your prospective tenant’s hat on? What are some vacancy rates looking like today? Raphael Collazo, a commercial real estate agent specializing in retail will share his insights.
Tell us a little bit about you.
I was born in northeast Italy, my dad is Puerto Rican, he was in the Air Force, he was stationed on the Aviano airbase, he met my mother and they had me and my twin brother. We traveled around Europe, I lived in Italy, Germany, Belgium, and then moved to the United States when I was 14. I went to school in Arizona State and studied in industrial engineering and economics, and then got into software. I was a software consultant for a company that implements software systems for government agencies, and I worked in DC for a few years. I was in Puerto Rico on a large tax software project, and got moved to Louisville, Kentucky after Hurricane Maria, the project got put on hold in Puerto Rico, which eventually moved us to Louisville, Kentucky. I transitioned from software into commercial real estate brokerage back in June of 2019. And I’ve been doing it ever since.
Since then you wrote a book titled “Before You Sign That Lease” which is tailored for people that are looking at potentially getting a commercial space. As investors, we have to put a hat on of our potential tenants, and commercial leasing brokers as well, why don’t we go into each step of your book and dive into some areas of it?
I’ll try to keep it tailored towards understanding the the client, which is the person who’s looking for commercial space, and then we’ll put the hat on as the investor and explain why it would be a value for you to understand that. In the book, we talk about why you need commercial space in the first place. I’ve had a lot of conversations with people who like the fact of having a commercial space, it’s a validation of them having made it, but in reality, they may not even need a commercial space. Let’s say you’re a web designer, why do you need a commercial space, it’s more of just fluff for you, you can be a trainer that can go to all of these different places, you don’t necessarily need a physical location. On top of that, it may not be in your budget, your business may not be able to support you having a commercial space yet.
Having that conversation early on is important so that you understand that maybe it’s not the right time. And that’s okay, it’s actually better to know that now versus you getting into a commercial lease for three to five years, and then having that financial commitment for another three to five years. That’s the first step in the book. And then we talk about some of the things you need to prepare before you go down the path of getting a commercial space, a lot of it is providing financials, because if you’re a newer business, or you haven’t been around as much as some of these more established businesses, put the investor hat on, why would the landlord want to lease space to a potential business that doesn’t have a track record of success, that’s very risky for an investor. If you can show the financial strength to be able to say, there’s a 2,000 square foot space, and it’s going to be $2,000 a month, I have $40,000 in reserves, our business is producing this, we can support this type of payment, it’s getting ammo in the cartridge, so that as you go out and look for commercial space, you become a more attractive tenant to these potential investors.
Then we go through the process of narrowing down your list of criteria: how do you negotiate commercial leases, some of the provisions you need to keep in mind as you’re looking at commercial spaces. And then at the end, we talk a little bit about once you get to the point of getting the lease signed, what are some of the build outs involved if you need a build out, and then we share some marketing strategies, and at the end, we have a call to action saying Now take the action, do it.
And when they go ahead and do it, what are some of the things that they should be aware of with regards to negotiating that lease?
As far as negotiation is concerned, what I see business owners do is, and it makes sense, as a landlord you want to pass along some of the main responsibilities over to the tenant, because you don’t want to have to deal with getting calls for toilets and whatever else. That’s part of the reason why you’re investing in commercial real estate versus multifamily real estate. They want to be able to be a little bit more passive. Along with that, as a business owner, they don’t consider the big ticket items, the landlord could pass along the responsibility for the furnace, the AC, if there’s an elevator involved, maybe they’re also passing along that responsibility. And you don’t know that unless you read the lease. I had a situation where I was representing a small business, it was a international grocery store. And we were looking to sign a lease for 2,000-2,500 square feet. And in the lease itself, it said that the landlord is responsible for everything related to the furnace up to $250. Anything above that amount, the tenant would be responsible for, and we didn’t know what the age of this particular furnace and AC was, it didn’t look new. So we ended up negotiating and flipping the script and saying, Look, we’re responsible up to $250, or $300, and you’re responsible for everything else. That’s something from a business owners perspective that’s beneficial.
Along with that, if you’re in a multi tenant center, a lot of times you have to consider what’s the competition in that center, because you don’t want to be a liquor store, move into a multi tenant center, and then all of a sudden, next door, they allow another liquor store to move in. Having some form of exclusivity. We talk about sublease clauses, if you’re two, three years in your lease and all of a sudden, something happens with your business and you can no longer stay in that location, whether that’s for cash flow reasons, or maybe you’re just expanding too fast, then if you have a sublease provision in your contract, at least at that point, you have the option to be able to lease out the space to a “third party”, and it helps alleviate some of that financial responsibility. We talk a lot about different types of provisions in the lease. I’m not a lawyer, so I don’t want to give people legal advice, but those are just some of the things to consider.
Do you have the layer next to you as you’re negotiating these leases? And are you going item by item because they can be 30-60 or more pages long. What is your process? You’re relatively new, three years or so in the business, and very few people know all of the details and intricacies.
I have several lawyers that I work with that I say, Look, these three lawyers that I know, handle a lot of leasing, a lot of business law, these are the people you need to reach out to, and I highly encourage them to do that. I’m not licensed to offer legal advice, and I make that very clear. When I’m having a discussion with my clients I say, Look, I’m not a lawyer, I can interpret what’s going on, but I’m not going to say, this is what it is. So, yes, I definitely involve lawyers, whenever possible. And if there are any questions that they have, that are that’s outside my purview, I recommend them to three lawyers that I know and we’ve worked with in the past.
What are some of the major things that these lawyers have educated you on that you can think of?
It’s based on a lot of the provisions such as worst case scenario. I come from an engineering background, and in software, you’re thinking testing. You’re working with a piece of code, or a piece of software, you have to start thinking of all these scenarios of how they go on and then test out the scenario to see if it’s actually going to function as intended. In their case, they do it from a legal standpoint. They look at what if this random thing in this particular scenario happens. I don’t know all the moving parts in the background that I maybe I knew on the software side, because I was familiar with the coding and everything else. But in a business setting, especially in the commercial real estate setting, it’s going to be slightly different.
This may be unrelated to leasing, but Covenants Conditions & Restrictions (CC&R’s) for developments, what you can and can’t have in a particular location. In particularly when it comes to site selection or locations for retail properties or retail concepts. There are certain provisions within the the initial CC&R’s which is what the developers use to be able to dictate what can and can’t happen within a development that may impede the ability of a particular retail use in that particular center. I didn’t really have experience with that sort of thing. So now, anytime I look at some of these developments, I say, What do the Covenant Conditions & Restrictions say, so I can better educate my clients on whether or not it could be a good fit.
Take us through the process of someone who is looking at a location, what is going on through their minds?
I’m Latino, I work with Spanish speaking clients, a lot of them like to be located in corridors where there’s a high density of Spanish speaking clients. Location is very big for them, whether they’re grocery stores, or restaurants, etc, they want to be located in an area where they have those type of clientele. I had other business owners that are much more price sensitive, when it comes to their location, they don’t really care about whether or not it’s in this perfect location, they just want to make sure the price is okay. I’m representing a client now who is a person running a rug cleaning and repair business. They just need a warehouse space where they can clean rugs and repair Persian rugs. They’re going to be much more price conscious, because they don’t really care where it’s located. They don’t need a storefront, they don’t need a retail spot where people are walking on a consistent basis where there’s high traffic counts, they just need to have a space where they can operate. It’s different for different businesses, if you’re an industrial tenant, you’re going to want to be located near your major suppliers, maybe close to transportation arteries, like highways, airports, rivers, in particular if you’re bringing in product across different corridors, that’s why it’s very business specific.
What is the vacancy rate in your area right now? I understand it varies greatly with states, cities, etc. What is going on in your area at this point?
Like you said, it does vary. And it even varies on property type. For example, we have a location in Louisville called Bluegrass Industrial Park, it’s the largest industrial park in the state of Kentucky. You can’t find space there, it’s less than 4% vacancy rate right now.
What’s so special about that park?
The infrastructure, it’s built out to support those types of industrial uses. With the proliferation and the growth of logistics companies, in particular distribution companies, they’re all looking for locations. And in this particular area, it’s close to a major artery that can lead you directly to the airport. It has a major artery that can take you down south to Nashville, etc. Louisville being somewhat of a distribution hub, we have UPS here, FedEx has a second headquarters here, within 24 hours of driving, you can access about 58% of the US population. From a logistic standpoint, it’s a very good place to locate.
We always have a lot of people looking for distribution centers here in Louisville. Because it’s one of the main areas where these are located, then obviously that means that the vacancy rate is going to be extremely low, depending on the location. It’s going to be very different for retail, and then depending on the use. Retail is such an interesting type of business, because you have retail that tailors to a particular demographic, and then there’s another retail that can tailor to a completely different demographic, you wouldn’t put necessarily a Dollar General in a luxury mall. It really just depends on what the needs are of that particular market. Vacancy rates are going to differ based on whether or not you’re in a middle class market, or an upper class market or an affordable market, etc.
Is there a range in retail right now?
I would say five to 10%, depending on where you’re at, and maybe a little bit higher, depending on some the market. I would say below 15%. I have several restaurant clients that I’m looking for space for, and a lot of them prefer second generation spaces. What that means is that they’re already built out as restaurants. Restaurant build outs are exorbitantly expensive. A lot of these restaurant owners prefer not to just get a white box space, they want to be able to find a second generation restaurant that they can move into. And there’s nothing out right now, which is very surprising to me, because you would think okay, COVID must have affected a lot of restaurants. But there’s really not a lot available out there.
How about office?
That’s another interesting fact. I have several people that I’m representing, one being an engineering firm, they’re looking for 1,500-2,000 square feet. It’s not a significant footprint, but they’re wanting to be located in the East End. In Louisville, the East End is an affluent area, and there’s not as much inventory as you would imagine. Now, downtown has been struggling pre COVID. It was starting to recuperate after COVID, it’s really rough. We have significant vacancies downtown. They’re they’re actually having discussions with the city to try to see how can we revitalize downtown. I think the answer is converting some of those office towers or portions of those office towers that are no longer occupied with office users to some form of residential, businesses center around places where there’s residential properties, whether that’s condos or multifamily, etc. I think that’s the answer. And there’s other challenges that downtown faces here in Louisville, especially the parking situation, there’s a lot of one way roads, which affects the way that people navigate downtown. But I think one of the main answers to solving the problems with the people leaving downtown is having a lot more residential.
As real estate investors, I cannot imagine owning a piece of office in a space like that, but it goes to show that we all have the responsibility of being a driving force within the city to change that area for the better, change zoning, and all of that, and as soon as possible, it is within our capability and I think it’s really important for people to understand that you have to drive in all senses, especially when things are not doing well, with regards to your property.
It’s being that voice, leadership of the city is going to listen to the loudest people. If we can get a following of people saying, Look, this needs to change, what actions are we taking, and then hold them accountable to getting the results that you want. That’s really what it takes. It starts with being that vocal person, and then rallying people around your cause, and then acting as that leader to be able to drive change forward.
Is there anything that we haven’t covered that you think is important for our audience to know?
I think having empathy is something to understand as an investor. The reason I say this is because as an investor, it’s very easy to say I want to eke out every little thing I can out of a transaction. But a lot of times people don’t understand the opportunity cost of doing that long term. As an example, if you have a multi tenant strip center, a five unit strip center, and you’re eking out every single cent you can from each of your tenants, and then two of your tenants go dark, how long it’s going to take you to lease up that space? Maybe it takes you three months, six months, 12 months, I’ve seen centers that have been vacant for a year or more. What does that do to your returns over time, versus you getting an extra 5% or 10% in rent for a year or two period? Put your business owner hat on and say, Okay, how can I work with my tenants to make sure that long term, it’s a symbiotic relationship?
And that can also affect your other tenants, by having two vacancies out of five in a strip center, you’re affecting your other tenants that are not getting that traffic to their store or business. So you have to think holistically about your center overall.
They’ll want to leave. I wouldn’t want to be a business owner on a 60% vacant center, because you invite potential vandalism, you get a negative stigma around the property. A lot of it has to do with understanding that, put your business owner hat on, put your clients hat on and say, Okay, how can I make this so that it’s a great relationship for both of us, and try not to squeeze every single thing you can out of people that you’re serving.