What should you look for in an industrial property that you are looking at buying? What are some of the strategies to make deals a win win for the buyer as well as the seller? Darren Smith, Principal of Solid Growth Properties LLC will share his industrial investing insights, he has been investing in real estate for nearly two decades and decided to focus on industrial for the last four years.
What do you look for in a property that you decide to buy?
It’s such a wide spectrum of things that would work for me. I say that because my objective is to get a quality property with a quality tenant for a long term hold. I do flip properties, I have novated properties, but my goal is to hold them. I’m looking for a property that is in an area that I know that if it goes vacant, I can get it rented without a ton of trouble. And that be like what are my rates on the property? I need to know, how much is the lease on this property? Let’s say I’m buying one that already has a tenant in there, and rent is $8/sf plus NNN. If the market rate in that area is $7/sf plus NNN, I’m a little bit nervous, because if that tenant doesn’t renew in a couple years, if I paid full price for it, I’m paying above market rates because the market doesn’t bear that. But if I’m getting $8/sf plus NNN, but market in that area can bare $10, I’m really comfortable with that. So it’s not always just what’s the cap rate on the property, the cap rate is the first thing you look at, because that’s what is going in, how much am I getting a return on my money, but you want to look at what are some things that are going to happen to this property in the future.
If this tenant leaves, or what are some things I can do to this property to increase the things that I can do on it, if there’s only a 20,000 square foot building on it, maybe there’s an extra couple acres on the back that I can put another 20,000 square foot building on. So having the ability to increase your rents if need be, or increase the property itself to improve it, those are really the two things I look for. And then I’ll really do anything after that. I like self storage, I like small industrial, I like manufacturing, warehouses. Any of those can be great as long as I can get a decent tenant in there.
A lot of people love multifamily investing because you have one building, but there could be 10 units in there. There could be 100 units in there and it spreads your risk out among smaller tenants so that if 10% leave, you’re still collecting rent. I own properties that have a five figure mortgage payment due every month with one tenant. If that tenant moves out, you have to be able to ride that out and be able to pay your mortgage and pay your expenses until you get somebody new in there. One way that some people will segway into the industrial space is to do it with self storage, self storage is kind of industrial if you’re talking to individuals, 200 square feet, but small bay industrial is that next step because these are units that are maybe 1,000 to up to 5,000 but usually 3,000 square feet, they might have a small office, a drive in door, and you can have multiple of these in one facility. It serves that purpose of spreading out your risk. If you have 10 tenants in there, if one or two go vacant, you’re still able to make your payments for a longer period of time. So that may be somebody who’s looking to dip their toe into industrial, but, scared of having something a little bit too much to swallow, Or they could just start out with a smaller property, there are some great 5,000- 10,000 square foot properties out there in high demand right now, it’s very hard to find that size. And now your mortgage payment may be a couple of $1,000 a month. So if it goes vacant, that’s not hurting you nearly as much.
When you have a property with a single tenant in it, how do you prepare for that? How do you have a backup plan? Is it two years of mortgage payments? How do you approach it?
If you’re buying anything, having a plan B, having that backup is essential. The first thing I look at was where am I at compared to market rates? I like to know what am I renting it for, as a total or per square foot, however you want to calculate it. And then what do I need to rent this for, to break even? And so if I get in a situation where, it goes vacant, I have what I feel is sufficient capital reserves and liquidity and other properties, in the accounts that I can weather out a storm. Depending on the area, you could have up to a year. I own a large office building as well, and some of those can take even longer. You really do need to have significant reserves to make that happen. But also, if you start getting to the point where things are getting rough, if you can cut your rents by 20%, 30% or more and still break even, maybe it’s for a short time, but at least that saves you from losing the property, or having to do something drastic. Those are the two things I try to do: have a sufficient capital reserve, but also have my rents where I can cut them and be enough above that when I’m buying the property that I have that ability to flex if need be.
And sometimes those things are hard to find because you do need to buy a property that is a little bit cheaper than others, because you’d have to have that ability to cut rents by 20%. You just really have to do your homework, but it’s definitely something that is very important if something does happen to the economy, because that’s how people lose their properties, especially these multifamily people. They have zero ability to cut rent from the deals that I’ve seen people talk about.
I’ll just add 3% CAP, selling 1980s properties at 3 CAPs, and they make money, they’ve done really well in the last couple years. I don’t mean to knock it because these people have been very successful if they got it in the last five years. You can’t help but make money. But I do wonder what will happen in a couple of years when things turn. I’ll add one more thing. I have been wrong for at least the last five years, I probably was a 2016-2017 “We’re getting close to the peak”. I thought things would cap off at that point. I’ve been in this since 2003, 2004, I can say I absolutely saw the last crash coming. I can say I have absolutely no idea what’s going to happen going forward.
You did mention working with the seller directly and making something that works for you and for them as well. Are there other strategies that you use to make some of these deals a win win?
There are so many creative ways of putting deals together, you have to go into the conversation with an open mind by letting the seller know you’re there to figure out the best solution for them. I’ll tell you a funny thing that happened in the last couple of weeks. My assistant mailed out several months worth of marketing for me on the same day, and I have had more seller conversations in the past couple of weeks than the rest of the year combined. What that has given me is this, it has helped me with my skills of talking with sellers. I’ve been doing it for years, but you can always improve. Two, I find the things that I keep saying over and over to different sellers. One of the things I keep saying is, Hey, you know what, I may not be the best fit to buy your property, to be honest, I buy a lot of properties, but I definitely don’t buy everyone. If you can just let me ask you a couple of questions about the property, to understand that situation and then about your situation, what you’re trying to accomplish, what are you hoping to get out of the sale? What are you looking to do after that? If we can get through that, we’re going to figure out together what is your best option, and if it’s not me, I absolutely will tell you that. And I have told many sellers over the past couple weeks, It sounds like you should just do xyz, and list it with a broker, or keep it, or rent it out, or whatever the thing is, because I’m not the one that’s going to help them get to their goal.
One of the things that we can put together to help them is tax strategies. I do not have a crystal ball right now, it’s very murky with what’s happening with taxes coming up. But capital gains is obviously a huge factor for this. If somebody’s selling a building that costs a couple of million dollars, and maybe they’ve owned it for 20 years, and it depreciated down to almost nothing. If they sell that building at all at once, all cash, and they don’t have anything else to do with that money, that’s going to be a tax deferred strategy, they have to pay capital gains on that entire amount. I do have some people that are looking to get deals done this year, so that they don’t get hit with what may come next year, but I’m also hearing rumors that they could even back retroactively and implement some of these taxes. So that may not be the best strategy, if somebody’s thinking about that at the moment.
How I’ve helped people with deferring their taxes is twofold. One, I can give them more money, if they leave some of that money in the building. I’ve actually had one seller, I didn’t buy this deal, someone else snagged it before I could, but the conversation was, he said, I don’t want any money down, he wanted to 100% seller financing because he said, I don’t want to pay any capital gains, I only want to get interest on this, and I want to collect that for the rest of my life, that’s how I want to live. That was his strategy, not mine, I thought that was pretty brazen of him. But I have helped other sellers by leaving some of their money in the property. They say, I want to go buy a house on the beach, I need $500,000 in closing and leave the rest in, you only pay capital gains on the $500,000 and you defer the rest over time. They are paying taxes, they do pay capital gains as they receive the money in the future, but because they’re now earning interest on their money, they can pay some of that tax with the interest that they’re earning with the money left in the building. And depending on the deals, they can make some pretty decent interest on their money. And it’s secured against an asset that they know. What do you know better than a building that you’ve already owned? Maybe your business was in it, you know the area, they just spent the past several weeks talking me up about how great this building was, and how great the area is and that it’s going to be worth $10 million in five years. Perfect, then if they leave in money, and they know how secure that is, I give them comfort by showing them my track record, having them talk with other sellers that I’ve worked with, I have sellers that for years have been getting automatic payments in their account every single month. They don’t even think about it. When you can show them that you’ve done this before that helps. And if you haven’t done industrial before, if somebody says, I’ve only owned some rental houses, if somebody is looking for that kind of credibility, you can just talk about that track record, I’ve borrowed on these houses, and I’ve never missed a payment. They can talk with the sellers that you worked with in the past, however you want to build credibility, you can do that.
The other way that you can help a seller is, if they don’t want to leave money in a property, I’ve actually partnered with people that I bought properties from. They wanted to sell this property because they didn’t want it anymore. I wanted to buy their property, and I’m also buying another property here, property B. What we ended up doing was we made them a limited partner on the other property that I was buying. I bought this one over here, they took that money and they did a 1031 exchange, and they transferred it into property B because they liked that asset better. And now they’re limited partners, their only liability is up to the money they have invested in, but they’re an equity partner on that one, they’re receiving interest, they’re receiving payments, they didn’t pay a single penny in taxes because they move all the money over here. And it was a real win win for them. That’s just two examples. There are so many ways that you can help people but you can’t do it unless you’re sitting down and you truly learn and listen about their situation. What are they trying to accomplish? Go in with that mentality, that you’re not there to buy their property, you’re there to help them figure out their best option. And a lot of times you can be that option if you’re creative and if you have the resources, but if you’re not, do not try and push it. Don’t try and sell it because all you’re doing is turning that person off. You’re hurting your own credibility. I’ve been in conversations with people for years, I am still talking with them, we still touch base every couple of months because I was honest with them, I was upfront. They still say, Thanks for checking in, we still have this thing going on, we’re not ready yet, you can give me a call in six months. No problem, sometimes it’s a 30 second conversation, sometimes they’re an hour conversation, I learn about their grandkids, their last surgery and whatever else is going on, we’ll go grab coffee, I’m happy to do either one of those, however I can help them best is what I’m looking to accomplish. I’ll either end up buying their property or if I don’t, I got them to a better spot. And I know they’re in the best place they can be, that is what builds my credibility. That’s what allows me to walk into a seller and build that trust, the sellers can feel that, they know that, so just be that person for them and it will pay off for you in the end.
What has been your best and worst industrial investment so far and why?
On the good side, I fortunately have several I could pick from. On the worst side, I really don’t have any that I’ve lost money on. I’ll start with my worst one on a flip that I tried, I’m actually still involved with this, we’re at a liquidation stage right now, I’m not sure how much I’m going to lose on this but it’s probably going to be a six figure number. I talk about that not because of the fact that there was a loss, but the fact that I didn’t do any homework on this one. It was a flip that I bought sight unseen. It’s across the country, I’ve never been to that town, I was doing as a favor for a friend because he got involved with it. I sent my one of my employees over and he said, Oh yes, we can do this, we can make it happen. I’m not blaming him by any stretch, because it’s still completely on me the fact that I did it. I tell you that worst scenario, because when you’re getting in one of these things, I would recommend to walk every deal, especially for industrial. If you’re out there, learn about it, you probably don’t know what it’s worth, because the prices are all over the place, even my brokers don’t know half the time. It’s hard. So get out there, every time I meet with a seller, every time I walk a building, they tell me things that I didn’t know, things to look for, That’s that type of roofing improvement, or, we have this type of power split up, or this air, or the concrete is this thick, which means we can do this. If you go in with that learning mind, to learn as much as you possibly can, it’ll prevent you from doing what I am in the middle of right now, losing my shirt on a property because I didn’t go check it out. I didn’t do my homework, I didn’t research the town, I didn’t research this house, which turned into an unmitigated disaster.
As far as my best deal, these are much more fun stories. This was one where I was really able to help a seller out, and I love those scenarios the best. The seller had been trying to sell this property for a couple of years, he was getting close to the the end of the lease with the Army Corps of Engineers. It was a government tenant that was in the building, it was in an area that’s a bit more remote. He’d been trying to sell this property and couldn’t do it, it was listed with a broker. I sat down and talked to him. I said, what exactly is it that you need? What are you trying to accomplish? And he said, this is the number I absolutely have to have, and I have to have that because of these things. I said, Okay, great, we can do that. How much of that do you need in cash at closing, he told me the number, it was less than 70% of what the sale price was. This was a couple of years ago, he wouldn’t be able to get this deal done anymore. But I was just getting into industrial at the time and for me, getting the terms was more important than the price at that point. It’s not so much anymore, but that was where the less money I could put in by far was what mattered. We were able to work out a deal where I got a 70% bank loan on that property, it took about 15 different banks, but he held a 30% second on that property. So I literally bought a $1.65 million warehouse for $0 down, it cost me about $60,000 in closing costs, that was 100% of my cost to close that property. It solved his problem because now he got his money, he’s getting payments over time for that other 30%. But what made me confident that I’ll be able to do that, because it was coming up towards the end of the lease. And it’s terrible how the Army Corps does it. They’re only allowed to do one year leases, the way they write their leases is this was a 10 year lease, but it was a one year lease with nine one year options, every one of them giving the Army Corps of Engineer the right to cancel at any time with no rent increases through the entire period, and they had under three years left when I bought the building at the time. That’s what gave me the confidence to go in and buy that building because even though there was only a couple of years left on the lease, it wasn’t cash flowing a ton, it cash flows about $1,500 to $2,000 a month which is not that much for a $1.65 million property. I knew he was so much below market rates because the lease was written seven years prior, so no matter what happens, when that lease goes to renew, I’m comfortable because I’m enough below market rates that I can get this done with no problem, very likely raising the rates. But even if I have to cut down to my costs, that’ll probably be you know, 60% of what it’s renting for right now is where I’d have to be at, compared to what market rates would be, so I’m very comfortable with that deal. That’s probably my favorite one because it was one of my earlier ones that got me really excited and it was a big win. That didn’t cost me a whole lot of money to get in and I also helped the seller out in a big way.
Is there anything else that you think our listeners should know that we haven’t covered with regards to industrial?
Probably about a million things, I’m very much a student of this and always learning, but I think if they start with those basic premises and just get out there and start talking with people, start networking with brokers, go talk with sellers, go knock on doors and if you just get out there and take some action and start having conversations you’ll find out if it’s right for you or not. And if it is, that’ll put you well on your way.