When investors make the leap from investing in residential to investing in commercial, it’s as if they’re starting over from the very beginning. It’s a totally different universe, with new types of structures, new types of tenants, new types of leases, and more.
At the recent REIN Multi-Family & Commercial Investing Summit, the audience heard a presentation on commercial leasing from Jessie Lail and Reto Steiner of InDevelopments.
Here are the four key components of a successful commercial leasing strategy:
#1. Find a good commercial agent
“Find a good commercial agent,” said Jessie. “Do not find a residential agent for [your commercial investments]”. Lail was quick to point out that residential agents are valuable for residential but “you need to find the right commercial agent [with] experience in a specific asset. If you have an industrial condo that you're looking at, you want to find an industrial Realtor® with experience in the condo market. You do not want a retail agent… it's a very different type of class.”
Along with experience, you should also consider the agent’s commission rates: “What [are] his or her commission rates? Right now in the marketplace, when the times are good, agents are looking for a dollar per square foot. I've seen it all over the board [but] the rate is now a dollar per square foot.” Lail then clarified what investors should anticipate: “As the market goes down, it will go back to a percentage-based commission.”
Experience and commission are important but so is the agent’s plan to help you. So Lail advised the audience to ask about the agent’s marketing plan. “Lots of agents say, ‘I have a lot experience, work with me, I'll get it done.’ The key is HOW they’re going to get it done. Ask them, ‘What's your plan?’ How are they going to market the space? What type of tenants do they have in their own database?”
A commercial agent with experience, with the right commission structure, and with a marketing plan, is an invaluable member of your team.
#2. Find a tenant
“Now, finding a tenant,” continued Lail. The first consideration the investor wants to know is the tenant’s covenant. Lail explained it this way: “If I had a coffee shop, would we have a strong covenant? No, not at all. We have no experience, probably just a venture for us that we want to try. But if you had Starbucks as a tenant, is that a good covenant? Yeah. They kind of know what they’re doing, absolutely.”
“In commercial real estate you’ll sometimes get ‘mom and pop’ businesses. But essentially you want Type A tenants with good covenants.”
He later urged the audience to start looking for a tenant right away, even if the property is not complete yet. “Do your [tenant] due diligence early. Do not wait for the last minute to look for a tenant. If my building is coming up next year, when do you think I'm going to start looking for a tenant? Right now!”
#3. Establish good lease agreements
Once you have a potentially great tenant, you need a solid lease agreement, explained Lail. He then shared the strategies he uses in his lease agreements: “In every single lease that I’ve written, it needs to be escalating rent… if I have a five year lease with a client or a tenant, I want to increment each and every year.”
Then he gave a couple of reasons. First, “rate of inflation.” As inflation rises every year, rent should rise as well. His second reason: “I don't like to hold on to property too much. If I increment each and every year I will sell in my fifth year.”
He then gave an example with specific numbers: “If I bought a commercial property at a 10% cap rate and I incremented my lease, and I sold it at 10% cap rate, I'm still making money just on the cap rate manipulation but if I sold it on the market at a five cap with escalating rent, I'm making that much more. So, always, always escalate your rent.”
Lail also urged the audience to have a real estate lawyer review the lease agreement. “This covers your butt”, he said.
#4. Implement great management
“Now you’ve bought your property and you’ve found your tenant. How are you going to manage [the investment]?” he asked, rhetorically.
“The property manager needs to have experience,” said Lail. “You do not want to hire me as your property manager. I have no experience. I don't know what I'm doing. Hire somebody who knows what they're doing.”
But you need more than experience, you need a plan. So Lail added, “When you're hiring somebody, tell them to create a budget.” Along with your own budget, you’ll be able to create goals and a plan for your property to deliver the income and cash flow that you want.
In answering a question around what the property manager should do, he said, “Everything. They should do everything on a day to day basis.”
There are, of course, many more factors that go into successful commercial leasing and Lail and his associate Reto Steiner spent time answering in-depth questions and giving plenty of examples. But investors who are thinking about commercial leasing and want to start putting the pieces together in their minds should familiarize themselves with these four strategies – finding a good agent, finding tenants, establishing a lease agreement, and finding great management. Do these four things well and your commercial investment will come together.