On the heels of our latest Top of Mind episode on retail real estate, this episode dives into a unique area of retail, neighborhood strip centers, with Parker Webb, FTW Investments CEO. Parker has worked in retail real estate since 2013, and in this conversation, we cover cap rates and cash flow, how these centers fared through Covid, how to strategically improve and maximize property values, and best ways to negotiate tenant leases. If you’ve ever been curious (or skeptical) about retail, tune in to this packed episode.
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Is Retail Real Estate the Next Hot Asset Class? – Interview w/ Parker Webb
Welcome back to the Invest Like a Billionaire podcast. We have a really awesome episode for you today. And this is talking about retail real estate. Is retail real estate the next hot investment-
And why retail is not dead. So this is actually one of the go-to opportunities of 2022 and beyond. It’s really wide open running room. So if you don’t believe me, stay tuned.
And today we have an in-person guest, which is always a treat. And we’re joined by Parker Webb of FTW Investments. He’s the CEO. And Parker, thanks for coming over, man.
Yeah, absolutely. Thank you for having me.
I’m super pumped about this. This is going to be great.
Me too. Real excited.
Yeah. So this topic we’re going to talk about today… You can talk about a lot of things given your amazing background, but we’re going to talk about retail real estate, and this is something-
And everybody just tuned out, but please do yourself a favor. Do not tune out. This is going to be a great time to make money in retail.
So we’ve had several guests on the podcast over the course of the past six months, and it just keeps coming up. And the opportunity is to us too obvious to overlook.
And we wanted to get someone that’s an expert in neighborhood retail shopping centers. And it’s this kind of overlooked asset class in the grand scheme of real estate and right now is a very unique opportunity that we’re really excited to dive into. So we brought on Parker to talk about it. So Parker, tell us a little bit about your background, for those that don’t know who you are, in FTW and just kind of your background in retail, especially.
Yeah, absolutely. So I’ve been in real estate since 2013, where I really started cutting my teeth on retail sales and leasing. So we were doing everything from neighborhood center projects, power centers, kind of larger stuff. I did a lot of sales and leasing activity, which eventually led me to working with Midwest Retail Properties, which is now MRP Capital Group out of St. Louis. And really our niche there was we were specializing in buying Walmart shadow anchored shopping center. So you’re talking about a niche within a niche within a niche. This is small towns. You got a Walmart, and we were buying the little shopping centers that’s in front, with a Hibbett Sports and a Dollar Tree and all of that, hibbett rest in piece, but it was a really great business plan. And so this started to get us thinking more and more about that.
And as we’ve gone through, we were actually in the early COVID days doing a lot of retail work. And so we had a number of shopping centers, and then COVID happened. The whole world changed. Nobody knew what was going to happen. So we made a really strong move into the affordable housing space, which we’ve been playing in kind of class C and B apartments over the last couple of years and have now kind of reinvigorated really our retail program, because for us, we see a substantial amount of opportunity in neighborhood retail right now. And again, I’ve been involved in this since 2013. We’ve done neighborhood center leasing, sales, investments, redevelopment, development, really kind of the full gambit of really kind of specializing [inaudible 00:03:09] in that strip center or neighborhood center type of retail.
So pretty much every investor out there knows retail sucks. So tell us why they’re wrong and why retail doesn’t suck.
Yeah. And so I love the whole idea of like this whole retail is dead concept. And half the times I have that conversation, I’m sitting in a coffee shop in a retail center where someone’s telling me that retail’s dead. Or you’re sitting there at a local restaurant, and someone’s telling you retail’s dead. So retail, I think you have to think about this as there’s a lot of different kinds of retail. You have your super regional malls. You have your regional malls. You have your power centers and community centers. You have your grocery anchored.
Now, power center is what? Like-
Power center is going to be your Target backed with-
You’ve got sort of your big box retails.
Large, big box. Gotcha.
Absolutely. You’re talking about 30,000 to 120,000 foot, four plates.
And so where we’ve really seen a substantial amount of opportunity, and frankly, when you look at the retail landscape, the thing that’s been the most enduring has been these neighborhood retail centers. And a lot of these neighborhoods-
So not the big ones?
Correct. Yeah. And so historically, the entire mindset, it’s a total mindset shift. When you used to think about how do you structure a retail dealer, structure a retail property, there’s this idea-
You want the big box-
Because that draws the humans in, and then now they’re going to get their nails done and their dog groomed and buy their liquor and whatever else, right?
Exactly. Right. But when you think about this, they’re sort of posing figures. They’re these big things with these seas of parking, and they’re kind of hard to navigate, but then you think about the place that’s down the street from you within your neighborhood that’s got your coffee shop and your dry cleaner and your local restaurants and your local liquor stores or whatever else. Those are enduring places. And they’re convenient. I mean, A, it’s convenience, and B, it’s experience. The actual experience you’re able to get at a community center or a neighborhood center is a different kind of experience. It doesn’t feel like you’re going in there as a pure consumer, but rather you’re going in there to have an experience, sit in a beautiful place, sit on a beautiful patio, do some shopping, eat some food, have some conversations. And those are the kinds of places that we’re seeing that are enduring.
So it’s a reversal from the big box anchored, which was the thing, right?
That was the way to do retail, get next to the Target, the Costco, the Walmart. And now we’re seeing it’s actually the opposite. So this neighborhood retail, as you’re calling it, actually made it through COVID. Is that right?
Yeah, sure did. Yeah.
So talk about that.
Yeah. So, I mean, really we were all stuck at home here for a little while. And so what you saw was a lot of our normal day-to-day purchases started to move towards this e-commerce. And you say move towards e-commerce, but bricks and mortar still makes up over 80% of sales. I mean, so retail is still actively doing transactions in this marketplace, but what you saw was those locations that had just a lot of stuff that Amazon could ship you. They weren’t doing as well. People who said, “Hey, if I can get that in a brown box on my front porch, I’m going to do that.”
But when it was the local coffee shop, the local restaurant, whether it was that local restaurant that you’re actually going to go to or pick it up at a pickup window, or you’re going to pull up your phone with an app and still get food from that location, they still saw a substantial amount of sales coming out of those locations, because as it turns out, even throughout COVID, although some of us forewent haircuts and all that for a little while, there was still a period of time when you needed to get a haircut, you wanted to go get your nails done, you wanted to go stop into a liquor store and look at a couple bottles of wine and be able to pick something out that appealed to you. And so those locations still drove traffic throughout the pandemic and have shown to be enduring since then as well.
I think a lot of times too the big headwind that most investors think of in retail is e-commerce. And so e-commerce has impacted retail. No doubt.
And the trend has been clear in that Amazons of the world and these other bigger retailers that are shifting more to online are eating into the overall pie of retail sales, but what we’re seeing… And we had some other guests on a podcast earlier… the industry is starting to normalize a little bit to where Amazon is running a net loss on most of the products that they sell online to get them to buy other things and to fund their cloud business, but it’s actually not that profitable to run a pure online retail distribution platform. It’s actually a hybrid is really where a lot of these big retailers seeing as the opportunity. But there’s these headwinds that you have that e-commerce where we’re starting to see the trend plateau and a lot of-
So yeah, some of the charts we’ve seen that we showed in a previous podcast is actually the plateauing of e-commerce. So it’s flat-lining. It took a huge leap up in COVID, but then has been flat-lined. And so I think a lot of the e-commerce, the giant e-commerce, the trend to replace retail with e-retail has kind of run its course. Is it fully done? We’re going to talk about maybe one area where it’s yet remaining, but it’s been done. And the cool thing about what you’re calling the neighborhood retail opportunity, you think about a restaurant, a nail salon, a coffee shop, a dog groomer. What else is in there?
Yeah, liquor stores.
Cell phone, mobile. You might have some artisan shops. You might have some bespoke or boutique clothiers. You think about places in Kansas City like Brookside or Prairie Village Shops or these places. You might end up with a grocery store, but it’s a lot of restaurants and the things that we would say are-
It’s mostly services.
It’s mostly services.
So it’s stuff that can’t be e-commerced, right?
Yep, 100%. And you end up, frankly, with some in neighborhood retail, it’s got a little bit of just kind of a vaguely neighborhood commercial feel too. That’s why you end up with your tax preparers or your CPA firms or whatever, because they want to have-
Right? The tax preparer. Yeah. So these are things that are never going to be e-commerced. So give us some actual stats, if you have them in the top of your head, of how they did through e-commerce. Did we see a big dip in neighborhood retail?
So we didn’t, actually. I mean, we saw-
We did not?
We did not see a big dip. I mean, neighborhood retail was able to maintain occupancies. It was able to maintain-
Sales throughout the pandemic.
In spite of… Because obviously restaurants had a huge kind of restaurant apocalypse, although it was fairly short-lived really.
Yeah. It was. I mean, and honestly, and things like PPP really helped solve some of those problems in the interim and the short-term. We had a whole lot of folks. I mean, what you ended up with was it was the fear. It was the fear that what is happening. We were able to put systems in place to manage through the pandemic. And don’t get me wrong, it was a struggle. A lot of people got sick.
But we didn’t see vacancies.
But we didn’t see vacancies across it. Now, where we did was in some of those bigger box stores, we saw some vacancies, and we saw some really re-touring-
Some changings of floor plates and floor plans and a revisit of how retailers are thinking about retail. And you’re seeing smaller floor plate plans or whatever, because you think about it, it’s a logistics nightmare. If you’re on Amazon and you have to deal with all these returns and where are they coming from and you got to send them a box, send them a label, I mean, it’s a logistics nightmare. But if you have a place where you can actually go and that kind of reverse logistics system as well, you’re seeing people trend downwards as well towards smaller sizes and things that are going to be accessible even in neighborhood and community style centers.
Okay. So let’s talk for a second about cap rates. Okay, and we always want to make our podcasts accessible to the less-sophisticated investors while maintaining a high level of knowledge and sophistication. Cap rate is basically the price you pay for a dollar of earnings. So if you got a million dollar investment, a 5% cap rate is what? 50,000 a year? Is that right? Did I do that right? So it means if you made a million dollar investment and you bought it for $1 million and it’s earning 50,000 a year, you paid a 5% cap rate. That’s the earnings you can expect unlevered, without debt, on an asset. And so it basically is the price of the asset. So if it’s a 1% cap rate where you paid the same million dollars only got you 10,000 of earnings while you paid a lot more for that asset.
And so cap rates is kind of the price you paid for an asset. All right. So what is the pre-COVID cap rates for big box retail and neighborhood retail? Pre-COVID, what were the relative cap rates?
You’re typically in the 6% to 7% range. So 6% to 7% meaning you’re talking about a 17, 18 times multiple on earnings.
Or net income.
So 7% to 8%, which is great. I mean, so right now post-COVID, we’re seeing multifamily cap rates at 3.5%, right?
So basically you doubled. You’re paying twice as much for the same dollar of earnings.
Right? Okay. Now going post-COVID, what are we seeing cap rates? And so there wasn’t much difference between the big box retail. They didn’t have a higher cap rate, or a lower cap.
It would depend. So your brand new, 10-year, 15-year leases, you might see 50 basis points. So it might be six and a half for that big box. It might be seven for that neighborhood center. And largely, it was a function of credit because you got this corporate bond rated credit as the-
As a lessee, right?
If you’ve got a credit rated person leasing your place, it’s worth more, right?
Exactly. And so typically since you had those larger corporations or whatever that had S&P or Moody’s ratings, you could actually evaluate their credit. So the smaller stuff, you didn’t as much. So you might see about a 50 basis point change.
Okay. So post-COVID, what are the cap rates we’re seeing in retail? It’s got to have gone up, because-
It has, absolutely. And one thing that’s interesting is it’s both gone up, and the spread has widened. So we’re used to maybe be say 6% to 7.5% averaging-
Kind of across the board before on a pre-COVID basis. Now we’re saying eight to 12, kind of depending on the asset.
Wow. Eight to 12 cap rate?
Yeah. I’d say the vast majority being in that eight to 10 range, but even some stuff, it’s experienced some distress or perceived distress, you’re staying in that 10 to 12 range, and that would be for some of the larger, big boxes.
So just so our listeners understand the math-
This is crazy.
So if air is something that’s a six cap that goes to a 12 cap, the price went in half.
The price dropped by 50%.
Just FYI. So that’s the scale we’re talking, is pretty massive. So retail all across the board has sold off, and yet you’re telling me that it went through COVID, these neighborhood centers-
You have this gap in the marketplace basically between the perceived risk and the actual risk.
There you go.
And that’s where there’s opportunity.
Perceived risk, there’s a huge deficit, or a huge difference between perceived risk and actual risk here. And this is, this is why I’m so excited about this podcast, is cap rate differentials. Isn’t that great? But no, this is the time to make money. As Warren Buffet will tell us, it’s when there’s value when the values are cheaper, and that’s when something falls out of favor, but it’s a great business, but it’s out of favor. Well, retail right now is out of favor. We’ve called some investors and just gone, “Hey, what do you think about retail?” And they’re giving a lot of pushback. And honestly, this is the place to be right now. It really is. It really is. It’s the place. If you can get a 10 cap rate, 10% return on your investment unlevered, that is a good deal. And once retail goes into favor and it goes back to its six or [crosstalk 00:14:58] seven cap rate, you’ve basically gone up 50%.
Another piece of that too, cap rate is one metric in a vacuum, but that also means you’re generally going to be cash flowing day one.
You mean you get paid money actually?
You get paid money.
That has gone the way of the dinosaurs lately in some of these real estate-
In real estate deals, it’s kind of a foregone conclusion that you’re actually going to have cash flow, except for two to three years out, like these multifamily deals, right?
And sometimes it’s worth the risk to do that, and it’s a good business case for that. We still love those deals, but especially when there’s turbulence in the market, if there’s risk of an economic recession, which we’re not saying there is, but having cash flow, cash flow is king.
It doesn’t get any safer than having money coming to you every-
And especially cashflow that made it through COVID. You know it’s going to happen. People are going to get their hair cut. They’re going to get their nails done. They’re going to go to the liquor store. They’re going to get their dog groomed. They’re going to stop with the UPS Store. That just doesn’t stop.
In a pre-COVID world, we were talking about these neighborhood centers is being e-commerce resistant, because you have these tenant bases of things that we still need to go to and we still go to and that we cannot shop for online. I would love to see Amazon be able to get me my coffee in the five, 10 minutes of my local coffee shop and get it to me. They can’t do it. And I don’t actually want to see Amazon do that. They can’t do it. And so that’s huge. But now what’s interesting is we’ve not only seen these things be sort of e-commerce resistant, or being able to resist that transition to what I would call now the omnichannel strategy for retail, which is really the idea that there’s a sales both online and in store, but these neighborhood centers we’ve now shown, okay, they’re e-commerce resistant, and to a certain degree they’re pandemic resistant. So we’ve sort of added another checkbox on how these things have been able to fight through the challenges that they’ve seen.
And here’s kind of the thing too. I mean, everything goes in cycles. Everything is in favor and out of favor at different times. And [inaudible 00:16:56] I botched it the other day, but be fearful when others are greedy and greedy when others are fearful.
Ah, that’s such a good quote.
Right? And it’s this contrarian approach to, hey, you don’t want to be buying at the top of the market. I read another one the other day. [inaudible 00:17:11] got so many good [inaudible 00:17:14], but oh, I’m going to forget it. But anyway, the idea is being contrarian in the way you’re approaching you’re investing. And don’t put all your eggs in the basket, but dealing with a cash flowing like we’re seeing right now, that is going to attract bigger money eventually. Capitalism. Money flows.
And once it becomes in favor and your 10 cap goes to a five cap, which is half of what some multi-family deals are doing right now, you’ve just doubled your money.
Yeah, without doing anything to the property.
And if it goes to a two and a half cap someday… Who knows? you’ve just quadrupled your money. And so buying out a favor makes a ton of sense. And I’ve always said… I mean, I’ve been in the markets a very long time. People think the markets are rational. Markets are not rational. Okay. Warren Buffet said, “If markets were efficient, I’d be broke.” And that’s just the truth. People pay more money when everyone says it’s a good deal, everyone. And people pay less money whenever someone says it’s a bad deal, regardless of what the numbers say and regardless of that. And so this is the time to get in this. And, I mean, we’re looking at some multifamily deals, and we’re seeing multifamily at three and a half cap rates. So you’re earning three and a half cap unlevered, 3.5% unlevered, but your debt cost is 5.5%. And so actually, you’re paying more on your debt than you’re earning from the property. So every dollar of debt, instead of boosting your returns, diminishes your returns.
And that’s why even on those properties, when you’re 60% loan to value, you’re maybe one owed that service coverage ratio. So you can’t get very much debt to support that. Otherwise, I mean, you’re going to just be anticipating writing a check.
I would argue that is way higher risk-
That you’re taking on than another retail.
Okay. Now, you gave another really cool stat, okay, that I’m super pumped about. And this was the percentage of neighborhood retail that is owned by institutions.
Yeah. So you might have the exact percentage in front of you, because I don’t remember-
3.6. Exactly. So it’s so low when you think about this. So over 90% of properties in the multifamily space, over 50 units, are owned by institutional groups or sophisticated investors who are in that space. The vast majority of these neighborhood centers are ma and pa-owned. I mean, this is the same opportunity that people saw in mobile home parks a decade ago.
Wow. So literally this stuff is owned by mom and pop owners who typically we know not sophisticated financially. They’re not great investors. So they don’t necessarily know how to maximize the value of these properties. They don’t know how to improve them, how to get rents up to market rates or any of this stuff. So it’s ripe for what we call a value add strategy.
And it’s ripe for what we call a roll up strategy, where you take all these things and you put them in big pools of loans that institutions can buy. You can understand why the institutions are not interest, because they’re lower priced too. These are smaller, lower-priced assets. It’s not efficient to buy them one at a time. If you’ve got to deploy $10 billion, you don’t want to buy these, but potentially if they’re aggregated and well-managed, then-
Well, it’s the same thing with mobile home parks. They’re also lower basis, and there’s been a lot of consolidation in that industry. So it’s not out of the question by any means.
Right. I mean, think about these large institutions. They cannot spend the resources to allocate or to keep buying, say 50 space mobile home parks or a whole bunch of properties that are $3 million to $5 million. It doesn’t make sense. But that’s why there’s such an opportunity for those of us who can go in and actually aggregate those opportunities and put them together. And now you’ve got a hundred million slug, or you have a 250 million slug. That’s something that makes sense to those investors. And frankly, at that point, also that sophistication in capital has a lower cost of capital, meaning they can pay more-
For what you’re selling.
Parker, this really is a great opportunity in this time. I mean, you have this wide open space. It’s ready for consolidation. It’s ready for professional management. And it’s on fire sale right now because of perceived risk that doesn’t exist. I mean, does it get better than that? Right?
It’s a sweet deal.
So talk a little bit about how do you actually create value in a strip center.
So you’ve done this, right? You’ve taken the stinky, old, ugly strip centers and gave them dress ups, right? So does it work?
I mean, how does it work? What do you actually do?
Absolutely. And so let’s start with the idea that let’s change the premise of how we’re viewing these things. And so it used to be that this strategy was you got a new anchor, and that new anchor drove more traffic. So now what we like to do is we really think more about what does the geography look like? And what are these institutional anchors that are going to naturally drive traffic? So neighborhoods that are rapidly growing, shopping areas adjacent. You look at hospitals or education or whatever. So you see, and you kind of map this out and say, okay, this spot is in a good place. So this is a A area or a B area, because of these institutional anchors that I don’t have to pay for their credit, but they’re in my neighborhood [crosstalk 00:22:20] traffic.
So institutional acres, hospitals, others that draw traffic to this intersection, et cetera?
So first we look at that as part of our evaluation of the analysis. And we look at demographics and income and all those things. Once we determine that there is-
It’s a good area.
Yeah, it’s a good area, then we say, okay, if we have an A or a B area, but we got this thing that’s a real dog… It’s a C or less kind of property… then there’s opportunity. So when you think about this, I mean, the first thing that you can do-
So you’re looking for a C or C minus property, if there is such a thing in an A or B area?
That’s correct. Yep.
Where all the patterns are going, you’re in the path of progress, et cetera. And so then where we have an opportunity to really increase value, the first one you’re going to look at, and the one that I think is the most important to start, is deferred maintenance. If the asphalt looks bad, if the concrete looks bad, if the lighting looks bad, if you drive by that shopping center at night and it’s dark and scary and you wouldn’t want your wife or sister or daughter or anybody like that to go there, then that means it’s probably a great opportunity for someone to come in and fix those problems to elevate just initially. If you have a leaky roof, if you’ve got bad HVAC, all that stuff, first you satisfy those things. And so you want two things. You want confidence from customers, because now they’re saying that there’s ownership that actually cares. You want confidence from your tenant base, because they see that there’s ownership that actually cares.
I mean, that’s nothing. That’s not much, right?
Right. Exactly. And that’s-
But it creates a ton of value. Just make it safe, bright, inviting, clean.
Yep, 100%. And then there’s some aesthetic things you can do. You can improve facades. You can improve signage. I mean, signage is so huge for these retailers because so much of their traffic in these neighborhood centers comes from someone driving by or walking by and saying, “Oh-
Seeing the sign.
“This coffee shop’s here. I hadn’t seen that before,” because when it looked terrible, they were blind to it. So you start to improve it. You start to improve that, signage, the landscaping and doing all those things and bringing it up to a modern look in a way that a modern shopper wants to do. So how did that add value? Number one, I mean, the biggest and most important way that it added value is it brought people to the center, because once you solve those problems, then you drive traffic. When you drive traffic, you drive sales. When you drive sales, there’s this thing we talk about in retail real estate called the health ratio, which is basically the rental rate divided by their total sales. And so if a company’s paying $100,000 a year in rental rate for the shopping center, but they do $1 million in sales, they have a 10% health ratio. So you want to be able to see somewhere in that kind of 8% to 12% historically for health ratios has been a pretty good health ratio.
And so you want to be able to drive sales, because when you drive sales, you can drive rents. But first you have to think about, well, I’m not going to hammer this guy with, “Give me that rent increase now.” You show them what they’re going to get. You show them that you care. You show them that you’re going to take ownership of it. You’re going to control the problems. You’re going to drive traffic for them. Then when those rent increases happen and they say, “Well, my income’s up 20%. I don’t mind a 5% or 8% rent increase,” you can show them that it’s good for everybody. And so that’s really what you do, is you deal with the deferred maintenance, you deal with safety and lighting and security, you drive traffic, and then that allows you the opportunity to drive revenue for the shopping center as the owner by driving up rents.
The next piece that we look at is, especially in these neighborhood centers that are largely owned by ma and pas, they don’t negotiate a lease as well as I do most of the time. And so we have the opportunity to go in there and look at that lease and where the normal lease is triple net in retail, which means over and above your base rental rate, you’re going to pay me an additional for taxes, insurance and your pro-rata share of common area maintenance. A lot of times these leases have caps, or they have their gross. And so there’s this market that says these guys are paying 10 bucks a foot. Market’s 15. These guys are paying a gross, but there’s usually $4 more on taxes, insurance and cams. These guys should be paying 19, but they’re paying 10. So you have huge opportunity to restructure that lease and get the rental rate up.
And that’s where you end up picking up both your… You can cut expenses through those capital expenditures, and you’re paying for the ongoing repair and maintenance.
And if you’re improving the property, and like you’re saying driving more sales to the tenant, they might be willing to accept that, and it’s not going to be as big of a deal.
Wow. I want to buy a lot more of this.
So we’ve actually got a project we’re working on together, and we’re going to hopefully be the first of many, but we’re seeing, I mean, just wide open running room, getting 10 cap rates on these properties and simple improvements. And so everything you just said for value add, it’s not that expensive.
Nope. I think what it comes down to is understanding who your customer is. And your customer is the retailer who’s paying you rent, but ultimately it’s the person who’s buying from them. And so you have to get your head into that mindset and say if I wanted to drive traffic here, what do I have to do? If I’m in this retailer’s shoes, how do I get more people to come here? And then you implement those strategies to make that happen. You drive sales revenue for those retailers. You look like a hero because you’re helping drive their sales as well. And then that ends up improving the bottom line for the property. And so you execute the strategy across the board. There’s some other opportunities to create value. So as an example, one of the projects we’ve talked about before, at one of our shopping centers, we had an out parcel. And so this was this old, crummy building, and there’s a tenant in there. And I was able to negotiate to move that tenant in line with all these improvements I was doing to the shopping center. I then started working on the improvements of the shopping center and was able to go out and sell that pad site. Well, as an example, we had-
So the pad site is just that spot that’s out by the road. So the strip center was back away from the road, parking lot. The pad site is this higher value, more visible kind of thing by the road, right?
Okay. So you took this tenant out of there and put them in the normal, in the regular mall there, or a strip center, and then freed up this pad site?
And the reason was, I mean, the building was not in good shape. The pad site was not in good shape. And so the argument was, “Look for me to do what I need to do to the shopping center, I need to move you in so I can tear that building down.”
And then being able to do that because that will then drive more traffic. Even though you’re out on this pad, you’re on this pad in a terrible building.
So you tore the pad down, and you rebuilt it? Or you-
Before we were tearing it down, because we had a plan to tear it down and do another pad building, we had the opportunity to sell it. And so to use simple math-
You sold it off? You sold it off?
We took that property. We were able to sell that pad site for 150% of the equity that we put into the entire shops.
What? Wow. So you sold the piece of it for what the whole thing cost you?
Yep. So it was a huge impact to that return obviously. It allowed us to go execute a strategy, get a great tenant who built a beautiful bank building there. And so that kind of thing is another way that you can do that, is you can either look at those pads and think about how to reposition those pads, or in a shopping center that may not have pads or has additional space, can you carve a pad out? Can you make room for a pad and do that same strategy?
Is there ever a case… There’s this great little retail neighborhood center over by my house that they really revamped and put, I think, too much money in, but I like to go there now. It was a place I avoided. Does it ever make sense to kind of overdevelop or to do a heavy value add?
So there’s always kind of a modeling exercise you have to go through. And you have to determine where it makes sense and where that dollar per dollar break even is on a certain amount of input. What I will tell you is that historically retail has actually been one of the best positioned places for tax incentives. So TIF, it’s really designed for retail. CIDs, designed for retail. So in the event… And we’ve done that in some of our projects… where there is sort of the positioning of the property’s in a really good place to sort of overdevelop it, but the numbers still don’t make sense. You have these opportunities to actually leverage these things like getting tax increment financing or getting community improvement-
Okay, so explain what a CID and a TIF is.
Yeah. So a TIF is basically a way where you take the future sales tax revenue… So let’s break this down. Say you’re currently paying $50,000 in real estate taxes for the year, but in the future project, after you go and do this new development and all that kind of stuff, those taxes are going to go up to $150,000. So that increment of $100,000, using that TIF financing, what it allows you to do is collect that extra 100. So you still pass that item through to the tenants. The tenants still pay that new assessment, but then you as the developer actually get the benefit of that additional revenue, tax revenue.
So the city pays you?
Correct. And so over a period of time, basically you’ll create a TIF district. That TIF district collects that additional tax revenue, and then you get it. And so over a period of 10, 15, 25 years, instead of paying that additional taxes, you’re the tax collector.
And so that helps provide additional financing and revenues to justify that cost. A CID, a community improvement district, you can either do it as a sales tax or an ad valorem tax, or real estate tax.
And it’s a typically 1% sales tax that you levy to the shopping center so that when customers are coming through and they’re buying their goods and they get that receipt and it breaks down how much of their taxes went to what place, you’d add that 1%, and that’s collectible revenue to the shopping center developer for redoing that. And those two tools, TIF is sort of a longer process to go through, a lot more legal, a lot more paperwork, CID a lot less of that.
So a city has to approve this?
So it’s a big process and all that, but generally they probably like it because it’s a way to improve their area, make it look better.
Right. And additionally produce more sales tax.
Yeah. And maybe they’re giving it away for 10 years, but then they’re getting the next 100 years, right?
Right. Yeah, and them TIFs, you can you’ll combine the real estate taxes as well as sales taxes in the center. And so at the end of the day, I mean, when you look at city’s budgets, so much of it comes from sales tax revenues from retail. So the fact that you’re going to do something that’s going to drive up revenues-
They’re going to love that.
You’re going to improve a property, they love it, because you’re going to be driving money to the city’s budget so it can continue to provide better city services.
But it’s hard to get, you’re saying? It’s kind of pain.
It is. And that’s why you have to kind of run this calculus to say do I go this far with this development or this far with this development? What’s the expectation-
And what does the city want? Are they willing and able to do this or not?
Yeah, exactly. And you have to kind weigh that calculus, meet with your city officials and see if it makes sense. Some cities are going to be a lot more interested in doing that. Other cities are not open for business.
Okay, that’s a TIF. What’s a CID?
So CID, it’s a 1% sales tax, typically a 1% sales tax levied. And you can combine them. So you can have a CID and a TIF all work together.
And those are a little easier to get?
CIDs, yeah, because you’re not talking about getting into the ad valorem taxes, and there’s not all this calculation. CIDs are usually an easier deal to get because the city doesn’t view it as having to give anything up. It’s just an additional-
It’s just an additional, yeah-
So have you been able to get a TIF or a CID in some of your projects?
So we’ve done CIDs on our projects. We have not done TIFs. We’ve evaluated projects if we were to take it that far. Ultimately made the decisions of going to CIDs.
And you were able to get them?
We have been able to. Yep.
Wow. So that just juices the returns, or lets you do a bigger investment.
Exactly. Right. And maybe what you end up with, the end product, might be a different level than if you didn’t have it. And, again, it’s a calculus though, because if it’s going to take you a year to get that, you have to make a decision and say do I wait a year?
Yeah, is it worth it?
Or do we start today?
We’re seeing right now purchase cap rates, just in, for example, a multifamily at 3.5% cap rates, which is very, very high, very expensive, we’re seeing you can build multifamily at a seven cap rate, so half the price. You can build for half what you can buy, these multi… So what we’re really liking right now is existing multifamily places that have room to develop a little bit, get a little bit of extra land or unused space. I’m wondering do you see the same opportunity in some of these older retail that may have too much square footage or too big of a parking lot? Is there a way to do have a heavy value add there that actually is very accretive to the project?
Yeah. I mean, where you see that additional parking lot, especially you have to look at how does it sit in the site? How does the site sit? And what’s the ingress and egress and all of that? But there’s opportunities. I mean, we’ve looked at projects where we’ve had excess land and excess parking, and we’ve said this is all one parcel, but we’re going to separately plat this into two parcels. We’re going to carve out this piece, and we’re going to sell it or ground lease it or do a build to suit on that site. And that’s a huge amount of additional revenue, especially if your shopping center’s over parked. I mean, typically we think four to six parking spaces per thousand square foot in the shopping center is normal. Four is usually the kind of go to. And so if you have additional parking that provides a huge opportunity to do that, I think there’s opportunities as well.
And some of these centers, grocery anchor, there’s some centers that are kind of want to be power centers, but they’re not. They’re not quite as big. They’re not whatever, but they might still have some junior boxes, the 15,000 to 30,000 foot retailers that are and maybe they’re not doing so well. And there’s other opportunity to think about that space and how do you redevelop that? Not just how do I re-tenant this, but how do I redevelop-
Give me an idea.
So as an example, I was brought in to consult on a project. We ended up not having enough score footage on this particular project to do it, but there was about a 15,000 square foot junior box space that just could not get leased. I mean, they were trying forever. And this was four or five years ago. And it sat there in kind of a funny spot, but the whole rest of the shopping center was doing great, but there’s just this one space. And so we looked at taking that center and basically demoing that entire thing and doing a multi-story self-storage facility.
And so we would’ve parceled it off, sold it off into a new entity and then self-developed self-storage. And so there’s other opportunities like that, to the extent you can get cities to buy in where you can think about this a little bit differently and-
I love it.
Apply some of that creative application.
I love it.
I want to shift gears a little bit. So we’ve talked about all the benefits and all the good things, but what are some of the drawbacks? What do you have to watch out for? One thing… I used to be a bank underwriter and have underwritten retail deals. The things you got to look at the front end are-
You’re throwing junk on our party.
No, no, no. You just got to be realistic. You got to balance, but Parker’s got all the answers, so I want to hear what he’s got to say.
No, I appreciate it.
So you’ve got to look at tenant improvement allowance, because generally in a retail, a strip center, the landlord’s going to pay for the tenants to move into one of the units or the areas there and improve it to their specifications. So there has to be some reserves up front for that. And then the argument too is within high inflation, you don’t generally have the same levels of increasing rent along the way, but what are other things to look out for? How do you think about what are the potential landmines? We’re saying that everything is awesome, and it is, but from your experience, there are some ways to not make it work.
Yeah. So I think you’re spot on. I mean, so TIs, tenant improvements, that’s one of the biggest areas you have to make sure that you’re setting aside for TILC, tenant improvements and leasing commissions.
And just, again, to be clear, I want to make sure this is accessible. So when a new tenant moves in, they need $100,000 worth of renovations, and you agree to do that for them with a bump in rent?
That’s correct. Or, yeah-
So you have to finance it. It’s really a financing issue. You just have to capitalize that, right?
Yeah. And generally speaking, the way that the market sits is that, say the market rate’s 15 bucks a foot or something. That would generally include some amount of TI.
Right. So it might include five to 10 bucks. And then you would say the additional amount that they might provide. So say you’re holding aside 10 bucks as market, but this tenant needs 30. Well, that extra 20 bucks a foot’s got to come from somebody. And so then you have to build that in, and that gets amortized in. So simply to not make that math hard. So say you had $20 extra a foot over a five year lease. That’s four bucks a foot per year of rent bumps. You usually build an interest rate. But tenant improvements in making sure that you have enough money there to set aside is usually important. One thing that’s a little bit different of retail with say multifamilies, generally a multifamily underwriting, you put the capex reserve on top. And so when we talk about cap rates, it’s usually capex is above NOI. Generally speaking in retail it’s below. And so you have to make sure that you’re thinking about that and understanding that aspect of it and truly underwriting down to cash flow and not just putting this number, just forgetting it exists, because that is an expense that you’re going to have to the property.
What do you normally see as a rule of thumb? What do you kind of generally want to see there?
Yeah. I mean, so rule of thumb, I set aside about 20 bucks a foot in this market for tenant improvements. And that’s generally, you’re going to see 20 bucks a foot will get you a long way with neighborhood centers. I mean, that’s a long way. Retailer, or restaurants might be 40 to 50 bucks a foot, unless it’s a second-generation restaurant space, which are in huge demand. So existing restaurants that then become vacant, huge demand to refill and backfill those locations. So over and above 10 improvements, I would say. You mentioned lease structures. So while, say multifamily every year, you can potentially raise the rent when those leases come up, to the extent that rents are going up. Retail leases are typically three to 10 years on average. And so where you don’t have the ability necessarily to push the rent as much as you do in the multifamily year over year because you have these fixed rate deals, but in those lease negotiations, you’re typically negotiating rental rate increases. Sometimes it’s a flat percentage. Sometimes it’s a flat per square foot number, but one of the things that you can do to protect yourself in this market, to the extent you are able to negotiate it, is you can negotiate those increases to be at CPI. And then as inflation goes up, your rental rate goes up accordingly.
And then when you think about it, if you have the true triple net leases, what you don’t get in multifamily is the ability to think about this overage. So every year in retail, for taxes and insurance and cam, you’re passing through true costs. So to the extent that inflation makes it more expensive for you to operate that property, it’s a straight pass through to the tenants. And multifamily, you’re raising that face value, but multifamily leases are gross leases. They’re going to pay you that one rental payment, and you have to take care of all the rest.
Yeah, so triple net, again, just to be clear means that the taxes, the utilities, the snow plowing is all paid for by the tenants. You just divide that up amongst the tenants. And so you don’t as a manager pay for that, or as an owner?
That’s correct. And so I think with a lot of these neighborhood centers, you have to understand when you’re buying, say is a hiccup, make sure if you’re buying leases that have two, three, four, five years left, and they’re gross leases, underwrite that appropriately, because if you’re expecting them to pay the taxes, insurance and cam, and they’re not, well, you’re going to miss out. But where you have that opportunity is to renegotiate that. You have that opportunity to negotiate that at renewal and really have a huge amount of opportunity to renegotiate those leases and provide more of a market rate lease structure.
Well, Parker, thank you so much for coming in and sharing some nuggets of wisdom. This is pretty cool. And obviously, we’re pretty excited about this asset class and see some pretty cool opportunity. So thanks for tuning in. Obviously, if you’ve enjoyed this content, please subscribe to the show on whatever platform you enjoy listening to it. And thanks for tuning in.
About Parker Webb
Parker Webb is the co-founder, Principal and CEO of FTW Investments. Parker guides the strategy, contributes to the investment thesis, and leverages a background in real estate brokerage, development, and asset management to identify and execute on investments with high risk-adjusted returns.
Parker started his career in commercial real estate in 2013 at Newmark Grubb Zimmer where he served in roles in the Sales & Leasing Division with a focus on investment properties as well as the Public Sector Consulting Division where he consulted developers and municipalities on economic development. After Newmark, Mr. Webb was Director of Acquisitions for Midwest Retail Properties, where he focused on acquiring retail investment properties. Simultaneously, Mr. Webb founded his first company, Third Space Property Group, a boutique real estate brokerage, consulting, and management firm.
Mr. Webb graduated from the University of Missouri – Kansas City with his bachelor’s in 2014.