Step 9: Find the Right Tenants

Welcome. This is the Insider's Edge to Real Estate Investing with James Nelson, the principal and head of Avis and Young's Tri State Investment Sales Group. In this program you'll learn game changing strategies to outperform the market. James will teach you how to source, execute and capitalize on the best real estate opportunities in New York and around the world. Now here's your host.

Welcome to episode number 126 of the Insider's Edge to Real Estate Investing. This is your host, James Nelson. I am principal and head of Tri State Investment Sales for Avis and Young. Thank you as always for joining. It means so much to me. I really appreciate the feedback I've been getting. As of late my LinkedIn page has been very active. So if you have not already, please connect with me at James Nelson nyc. Yes, that's me responding to your comments and questions and if I could ever answer them on the show, I am happy to do it. So thank you for those of you who have linked in with me. And while you're at it, you might as well check out james nelson.com. that is where you can find not only show notes in our past podcast, but you can also find an exclusive video series on the Insider's Edge to real Estate Investing. There's also a lot of helpful tips and references there as well. So for today's show we are going to be talking about step number nine of this 12 part series on finding the right tenants. So Rachel Hartman, my writing partner and I will be discussing this very important step in the investment process and these will all culminate in the book that yes, we will be having out early, early next year. So stay tuned. The title of that book is the Insider's Edge to Real Estate Investing to coincide with this podcast with a subtitle of how to outperform the Market. So that's what we're talking about today. How you can get that advantage and finding the right tenants for your building is super, super important. Investing is a partnership by bringing in these win win situations for both you and the tenants. So we're going to be talking about how these rents can vary and know about rent regulation, what to look for for a tenant as far as credit worthiness, and how to think about how to best position your property. And this is certainly important not only to fill vacancies, but also for some of those of you who are taking on vacant properties, how to best position them to maximize rent and your bottom line. So we're going to have a brief word from our sponsor and we're going to get right into this discussion on finding the right tenants. Thank you. A Different Approach to Putting Our Clients First Avis and Young's Tri State Investment Sales Group sells multifamily office, retail, development and specialty sales throughout the New York metro area. As experienced thought leaders in our industry, our 35 member group is available to help you make informed investment decisions by advising you on your current holdings or identifying new opportunities in the marketplace. Our one unified team is built on an industry unique platform which promotes unparalleled collaboration and teamwork. We share core values of hard work, integrity and expertise. We put our clients first providing tailor made strategies to achieve superior results. Please Visit us at aytristateinvestmentsales.com and follow us on Twitter LinkedIn and Instagram amesnelsonnyc to learn more. Welcome everyone. This is your host. I am principal and head of Tri State Investment Sales for Avis and Young. We are making incredible progress. I'm back here with my writing partner Rachel Hartman. We are on step nine. I cannot believe it. This is not like a David Letterman, you know, top 10 in reverse order. So you know, although at this point you've already acquired the asset, you've learned, you know last week how to how to manage it. Now we're going to be talking about filling that building up with the best tenants possible, finding the right tenants. So I know if you've not heard this series since we renamed the show the Insider's Edge to Real Estate Investing, definitely go back. The first show that Rachel and I did, I go through my story not only as an investor but also as a broker. Then we talk about why real estate and then Rachel, what else? What are some of the other steps that in case people are just tuning in for the first time to give them a sense of what we've accomplished so far.

Yes, I'm happy to share and it's definitely worth going back and listening to these steps in the order that because James laid it out in a way that's super easy to understand, follow along, make sense and best of all, you can apply right away. So we looked at different property types. There's a lot out there. James does a really good job of breaking it into some of these main categories and he also offers tips on what you might want to consider if you're a first time investor. We talked about the value of building up the right team. You definitely want others involved from the start. And James has an amazing network system and he shares some great tips on how to get started. There's also the concept we covered of finding great opportunities. How do you find places where you can really dig in and add value? We looked at the importance of a walkthrough and definitely listen to that episode. It has some amazing stories of walkthroughs that James himself has done. After that, we looked at some of the really essential financial factors like raising capital, signing, all that contract process. And we include lots of terms here and we will in the book that will help you get through that process. We moved on to what to do with that property once it's in your hands. That's a great show. That's really about adding value, making a difference. And now that actually brings us to today. Today we're talking all about tenants. We're going to dive into how to find the right tenants. And I really like this topic. I feel like there's a lot that can be said about it because there's different types of properties, so naturally you're going to find different types of leases. I'd love it, James, if you could get us started off by maybe talking about some of those differences. What do we mean when we're looking at a residential lease compared to a commercial lease?

Awesome. And always, Rachel, thank you. And, you know, you're very gracious to give compliments as far as the, you know, the material that we're covering. But it's really thanks to you and your research and your questions. And, you know, for those of you don't know, Rachel is a very accomplished business writer. Has been, you know, her work appears in Fortune Magazine Inc. And, you know, although she has written on the topic of real estate in the past, you know, Rachel, unless. Have you been holding back from me? You know, I don't think you have this massive real estate portfolio with thousands of units. So the fact that you're kind of learning as you go along and we're writing this together is perfect because we want to write this book so everybody gets value out of it. Right? It could be someone, you know, maybe you're in college, you're thinking about what's your next step? Maybe you just sold your tech company and you're sitting on $100 million. If so, please call me. But, you know, again, you know, going through these steps and learning that it's a process and how to build a network and what to look for. And Rachel, I think your questions are awesome because, you know, you're not asking these questions from the perspective of an experienced real estate investor who's got, you know, so we can't Break it down to its basic elements to explain what you should be doing. You know, again, then we're kind of missing out on, you know, presenting this topic in the right way. So I just, I had to say that. And again, by the way, if you've been doing this 10, 20 years or longer than I have, we're hoping you'll get some information out of this too. So I personally am always learning. In fact, I was on, I went to a panel this morning and talking about, you know, dealing with tenants and, you know, how things are going post Covid. And look, it was a tough time for everybody. You know, there was, I mean, tenants really, I mean, we didn't know what the future held. I mean, a lot of stores were forced to shut down. You know, employees were forced to stay home. And so a lot of these companies, you know, they really had to work with the landlords to, you know, to survive. And it, and it, it really involved landlords working with tenants as partners. And I really want to stress this and you know, because one of the panelists I heard who spoke this morning said, you know, maybe back in the day you'd sign a 10 year lease and then you wouldn't speak to the tenant for nine years until it's okay, it's time to renew your lease, right? He says now we are regularly speaking to our tenants and hey, how can we, you know, it is a partnership, right? Tenants need the utility of space. Landlord obviously needs the income, right? So, but again, you want to cultivate these tenants. You want to be, you know, maybe back in the day it was, you know, I'm going to cut as many expenses as possible, just deliver the bare minimum and, you know, try to squeeze every last penny out of this building. Like, no, that doesn't work. Like tenant retention, your brand, if you will. Having a good reputation. We talked in past shows about having a good reputation with brokers. Well, hey, have a good reputation with tenants. Like, you don't want to get the reputation. Oh, this, this landlord's impossible. You know, they're so difficult and they're not flexible. And you know, I'm not saying you got to be a pushover, right? This is still a business. But I want to stress that point. And I probably wouldn't have thought of that if I didn't go to a panel on a Friday morning in New York City. But that's what it's about. It's like getting out and let you learn every single day. So, Rachel, you know me, I can go off on tangents here. But I believe the original question was what is the difference between a residential and a commercial lease? So residential, most people listening, I'm assuming you've rented an apartment. If so, you know, or a house, you understand? I mean, this is pretty straightforward stuff. It's usually a one, two year lease. You know, that lease is pretty much a form agreement you're going to, you know, you're looking for, okay, what are my responsibilities? Do I have to pay my utilities? Does the landlord pay? Do I have any rights to renew? Look, in some cities or states, you have rent regulation. Rachel, we could do a whole nother show on the ins and outs of rent regulation and what it means in New York if you're a rent control tenant, rent stabilized tenant, I mean it, again, it's hours and hours of material, but I think for the purpose of the show, because we have a national, if not global listenership, we, you know, I don't think we need to get in the details there. That being said, on the residential side, you need to understand these things before you go into a market. If, you know, for example, and we're selling a property right now in Union City, New Jersey. Okay, well, Union City, New Jersey, yes, has rent regulations. So you have to offer your tenants the ability to renew at a set increase, which I believe is 3%. But please don't quote me, but that might be different than if you are renting an apartment in Jersey City. Right. So if the landlords are doing their job, they have to advise you, the residential tenant, of what your rights are. Right. So, you know, and if not, if the, the landlord didn't give you those that opportunity to renew, you know, again, there's recourse, but we don't have to get into all that. I think the point is that if you're going to invest in a multifamily, you need to understand, hey, in some states, like Texas, Florida, these are, you know, free market type arrangements. You know, if, Rachel, if you're renting an apartment in Miami and the landlord decides they want to double your rent next year, I mean, it's unfortunate, but, you know, hey, you might not have any recourse except to just pay double the rent or go find something else. Right? So again, if you're the landlord and you're the investor and you're in a market where you can't, you know, you can charge whatever you want, you know, a lot of investors like that. And that's why I've seen a lot of investors leave New York recently to go invest in markets in the Southeast because they don't want to deal with the rent regulation. You know, they say, look, I'm taking all this risk on if the operating expenses go up, I should be able to raise my rents. I don't want to be, you know, really, what's the word I'm looking for? Relying on the city to, you know, provide reasonable increases, which happens in New York City. If you own rent stabilized apartments, the rent guidelines board tells you how much you can increase your rent every year. Beholden, that was the word that I was using for. If we actually had, you know, we did a lot of fancy editing and went in and snipped and said, but you get one take here with us. That's, you know, that, that's, that's how we work, Rachel. You know, we just plow ahead here. So, but yes, there are, there's also trade offs on, you know, if you're buying property that is rent regulated, the going in return should be higher. Right. So if you can get a 4 1/2% return in new York because you can only increase the rent so much in Florida, it might only be a 3% return because you have that ability. So again, I still haven't answered your question, Rachel, about the difference between residential and commercial, but I had to at least kind of explain the basic parameters of the residential lease. I mean, yes, from a tenant's perspective, but I think it's really important for our listeners to understand what are the rules of how you rent out of apartments. Okay, let's move over to commercial. Okay, so commercial, we've got office leasing, we've got retail leasing, different types of leases. Right, okay. And different terms of the leases, different structures. So let's talk about retail leasing. I've told, you know, we've said before, I love the idea for your first investment of buying a mixed use building store on the ground floor, four or five, six apartments above. So a retail lease, it's usually pretty straightforward. Okay. So the square footage we're talking about is that square footage within the space. Net square footage. We're going to rent you this space and usually, and we're going to talk a little bit later in the show about what you need to deliver. You know, how do you deliver that space. But we're going to agree on a rent, this is how much you're paying me per month and we're going to agree on what expenses you're going to pay for. Rachel, are you, you know, hey, you're, you're, you're a restaurant. So you know, you're going to have to pay for your water and sewer. I'm not, you know, if you're, you know, running a laundromat, I'm not going to sit here and, you know, pay for all your water, you know. So that's going to be the tenant's obligation. If the real estate taxes increase, you're likely going to have to pay for the increases in real estate taxes over a base year. Okay. Now, in the retail world, the tenant typically does their own work, right? Unless if it's negotiated in exchange, the landlord will typically give the retail tenant free rent. Okay, Rachel, that's great. You're building out this brand new cafe. I've seen the plans. It looks great. I'm going to give you three months free rent. You're going to sign a lease, don't pay rent for three months. Instead of paying me the rent to spend it on the make the store as beautiful as possible and then start paying me rent. Okay. Whereas office leasing is, you know, a little more complex in that they are the companies really demand for the landlord either to build the suit, like give you a turnkey solution, or I'm going to give you a tenant improvement allowance. TI so you're going to rent for me and we're going to negotiate what it's going to cost to build out your space. And I'm going to say, okay, I agree. I'm going to contribute $50 a square foot towards your build out. You know, landlord, I might be the one to actually do that work. You've got a budget of $50 a foot. If you go over the $50 a foot, that's on you. Okay. In addition, you know, and especially these are all market driven, right? So when the market is soft, for me to entice you to rent space, I might have to give you a generous TI package, but I might also have to give you free rent on top of it. So these are kind of some of the basic differences. I will say when you get to retail, just going back, there are different levels, right? There's a gross lease. A gross lease is tenant just pays the rent, landlord pays all the expenses. Okay, then you have, and I should know, and people are going to say, james, how the heck do you not know what a single net is? But I'm sure there's a single net, but I'm skipping over the single net. We're going straight to double net. Double net is tenant pays utilities, real estate taxes, but they don't pay structural or roof. Okay? So, you know, you see this with a lot of the, you know, the fast food or, you know, what have you. And, and, you know, the tenant pretty much pays for everything. But again, if there's any structural issues, that's on you. The landlord, kind of the holy grail for the passive investor is triple net. So that is your Walgreens, your CVS tenant is 100% responsible for everything. Right. You know, again, if it needs a new roof, that's on the tenant, you know, and that sounds really great. Like, who wouldn't want the tenant to pay absolutely everything and take care of their entire space? And many investors do. But there's a trade off. If you buy a triple net with a credit tenant like a CVS or Walgreens, that might only get you a 4, 4.5% return when inflation is going like this. And for those of you who are listening, which is all of you, my hand is making a whoosh. Going straight up, which is unfortunately what we've been seeing with inflation recently. That might not feel so great, getting locked into a 4, 4.5% return over the next 10 years. So, you know, dealing with these kind of mom and pop, you know, these kind of tenants, you know, even if you're taking on some responsibility with the upkeep of the building and some of the expenses, generally they're going to pay more rent than what, you know, what some of these kind of tenants might be. So. But again, Rachel, I've already, like, there's clearly a lot of considerations here. Hopefully that was helpful. Hopefully I at least attempted to answer your initial question, but I know you've got a lot more and I hope I haven't taken our entire hour today in answering that first question.

Now, as always, you're right on. This is a wealth of information and just going back a few points, you know, when you were talking about how, yes, I've done a lot of writing, but as far as real estate, no, you are correct. I don't personally have a lot of experience with real estate investing, which is one of the things I love about this project. I feel like I could seriously, after talking, spending this time with you on these podcasts, putting together the book that's going to go out and the same material will be available to other readers, I feel like I could hit the ground running and go out and start investing, quite honestly. So I find that incredibly inspiring and encouraging about this project because it's so practical and down to earth. And so basically everything you say is great. Continue on. As far as questions, I wanted to cover right Some other things. Why don't we move into looking at brokerage fees or let's talk about some of the fees involved with leases here.

Okay, so there are, we talk about in the building, the team, what are the different types of brokers? Okay. I'm an investment sale broker, okay. I get hired by owners to sell their properties. Right. Okay. When it comes to leasing, right, you've got a residential rental broker, right. So they rent apartments. And on the commercial side, I mean it's always good when you deal with a specialist and when you're interviewing a broker, you want to say, okay, can you give me some examples of some other, you know, if you're, if you're renting a restaurant space, can you give me some examples of other restaurants that you have leased in the area? Right. So, and look, in some of these smaller markets, for those of you who are in secondary tertiary markets, sometimes you get generalists, sometimes that sales broker is your LE leasing broker also. And that's okay. I mean, if depending on what it is in a giant city like New York City, people are like hyper focused with what they do, right? So you could have a retail leasing broker on the office side. You can have landlord rep and agency rep. That, that's someone who is the, you know, oversees the building, offers the space on behalf of the landlord. You have a tenant rep. Okay, same thing on the retail side, you can have a landlord and a tenant rep, right? So two brokers bringing landlord and tenant together. So typically, and these are market driven on the residential side, typically the landlord is going to pay the fee to their rental broker. Right? But in a really hot market like right now, which, you know, here in New York, I mean, rents are at all time highs, that's again another show. We could have a conversation on why that's happening. But again, market driven. So right now landlords don't have to pay broker fees. The tenant has to pay fees. Right. So the tenant is going to have to pay the broker to find them space. Right. So it is, that can kind of go both ways. Now on the office, you know, on the commercial side, it is pretty standard that landlord is going to pay the commission. Right. And when you, and again, first thing, all fees are negotiable. Don't ever let you have a broker tell you otherwise, that, hey, this is the schedule, this is what it is. You know, that's, that's real estate brokerage licensing, one on one. But generally when we're talking about office deals, even some retail deals that are more, you know, institutional, larger Nature, there might be a one and a half times commission, you know, so full commission to the tenant broker who brings the tenant, the landlord rep gets a half a fee. These are usually done on schedules. X percent of the first year's rent, X percent of the second year, third year, fourth year, fifth year. And then those commissions are typically paid out in installments because from the landlord's perspective, and again these are market driven. If a landlord really needs tenants, they might say commission paid on signing. Brokers love that. When you hear, you know that's sometimes they even give away free cars and all kinds. Not free, but yes to the brokers, they are incentives to try to get the brokers to show their space. But generally speaking, and I think even the retail side because again I think some of our listeners, I'm sure they're going to go out and buy some office product. But that is a very capital intensive business. When you talk about the brokerage fees and the ti and the downtime, it could be two, three years before you see any rent, right? Retail, again, especially going out renting that mom and pop store, you know, generally you're going to be looking that maybe you're paying half that commission on signing when the lease is signed. But again, remember we're giving that retail tenant some free rent. So landlord, I don't want to pay the broker the full, the rest of the commission until that tenant is actually in the space paying rent. So I'm going to pay you half on signing and I'm going to pay you half after the tenant pays their first month rent. But again it's negotiable. Some landlords might say, hey, I'll pay you a third now on signing, a third on, you know, once the tenant goes in and a third on the one year anniversary, right? So it's, it's all negotiable clearly from the landlord investors standpoint, the less they have to pay up, the more they can pay over time, you know, because look, it is a problem if you pay your, your retail, you know, your broker a full commission and then the tenant blows out and never takes the space. You're out of commission and you've got, I mean that's, that's a problem, you know. So we haven't talked about security deposits. But look, if you guys want to learn about leasing, my friend Larry Haber, I'll give him a shout out. He's got his own podcast. He will teach you everything you ever wanted to know about retail leasing. He's got a show for every single little Tiny piece of a lease. You know, it could be the assignment provision. If I'm a tenant, can I assign this to someone else? Like, he has a whole show on this. He sets it up to music, and he's got, you know, he's got some great guests on the show, too. So this is. Again, we're trying to. Rachel, we're trying to give everyone some basic knowledge here so they understand the questions to ask you get a knowledgeable, trusted broker, they should be kind of walking you through this process. They should be advising you on how to structure at least what are the market terms? Right. And that's why you want to speak with, you know, multiple brokers. See what you know, they're saying, what is the market for free rent? Like, what is the market for ti. How do I have to deliver this space? Your attorney, also, there are attorneys, transactional attorneys. Most of them will do a sales contract. They will do a lease. They will do a bank work for a refinance. But for some of these complicated deals, you have attorneys who just do retail leasing. Right. And so making sure that you also have the right, not only the right broker, but the right attorney to draft the right lease. Right. Because the devil's in the details, you know, and some, you know, I would say the business deal is always hammered out between landlord, broker, and tenant. But the legal matters of, hey, you know, what happens if, you know, you know, you could come up with a million things. Force majeure is like the big thing now. Like, what if there's another Covid that happens and the tenant. You can't be open for business? Do they have to pay you rent? Well, you know, again, that was the number one question on everybody's mind. No one ever expected there was going to be a pandemic that forced businesses to shut down. Are they liable for the rent or not? Like, that was the fine print of the lease that people never read, and there was a lot of court cases. And so depending on how that language is written, I can guarantee you now, you know, there's probably three pages talking about what is a force majeure? What happens if it's a pandemic? What if it's this that, you know, what is the. What are the obligations? I mean, the devil is really in the details.

Exactly. And I think you hit on a couple of points that are important to this topic, and one of them is that just the complexity of leases. You know, sometimes we're talking about leases that go on for pages and pages. I think I heard it one of Your podcasts where you were talking about, about, you know, 100 plus page lease. So these are big deals. That's why, like you said, you definitely want to bring other people in who understand these terms. You yourself want to make sure you know what is what you're signing basically, and so you don't have to do it alone. I wanted to ask one question about. You brought up some market driven aspects, which I think are great. Another topic that comes up occasionally on your podcast that I think might be good to cover is that idea of concessions. So again, here we don't have to break down every single aspect. But I'm curious if you could talk a little bit, maybe an overview of how those might work, how that can be market driven to dive a little bit more into that.

Yeah. So I mean, the concessions again are really, it's usually the free rent, you know, so how long before they have to pay, you know, other milestones, what kind of work the landlord has to do? I mean that those are really the two major drivers and the rent. The big question then becomes how are you going to deliver the space? Right. So white box, you know, it means different things to different landlords. And so is it, you know, if you're going to deliver a space to a retail tenant, let's say you want to open up your cafe and it was a auto body shop before, are you literally just putting Sheetrock up and say, hey, there's your white box, or no, you're going to need hookups for plumbing, right. And you're going to need gas for your, you know, your stove. You know, that is what I would think most, you know, tenants are looking for is yes, we will do the actual build out, but from a mechanicals, you know, perspective, we want everything wired, we want everything set up. And so, you know, but that's really part of the negotiation. Like if there's no air conditioning in there, so who's putting the H VAC system in? Is that a tenant cost? Is that a landlord cost? So like, these are all negotiable, right. And again, and market driven, right. If the space is hot enough, landlords might say, hey, you know, you figure it out. I'll give you, you know, here's the keys, you know, have at it. But in other cases, like if you want a certain aesthetic or quality of tenant, you want to really present this space in the best way. And some if you're doing office, especially if the market's challenged, you might have to do turnkey. You need to build out the kitchen, the pantry, Bathrooms, glass conference rooms, this and that. Look, I mean, the benefits to that is someone could walk in tomorrow and open up shop. The negative to that, besides the obvious that it costs money to do that, is are you narrowing your audience of what they want? So if you've put up this beautiful glass conference room, but, you know, you're running to a tenant that wants a trading floor and just wants it open, you know, are they going to just take that glass wall down? Anyway? So, again, there's. There's a lot of considerations, and that's why a good leasing broker should be able to advise you, okay, this is the market. This is what you need to move the space. This is how you need to deliver the space. Right.

And when you. We talk about bringing on tenants, I think it might be worthwhile going over how we. How tenants are vetted. Again, I'm guessing that it differs based on the lease type of property and such, but, you know, tenants are such a big deal when it comes to the return and the cash flow. You want to make sure that you have someone who's credible and such. So I'm curious if you can talk a little bit about that credibility process.

Super important, Rachel, because, look, I mean, the. I hate to bring up the pitfalls, but you have to, right? Because, I mean, we can always talk about all the great things that can happen when you're doing your investment. There's also a lot of things that can go bad and finding the wrong tenant. And look, everyone wants to give that aspiring entrepreneur a shot, that person who says, look, I've always wanted to own my own business, and I really, I'm great at cooking, and I want to open this restaurant, but they have no idea what they're doing. And it's a lot of work. You know, that's why you see a lot of these professional restaurateurs. They've got a dozen locations because they know it's a separate business. Right? So you have a lot of people have good intentions, but you are taking a major risk. If you were dealing with someone who has never opened a store before, you are much better off if you deal with someone who's opening their second, third, fifth location. Right. You clearly have to look at the financial wherewithal of the. Of the tenant. You know, you are going to take a security deposit, typically. And again, go to Larry Haber's show. He'll tell you, you know, look up one of his episodes on the Good Guy clause. Typically, the way these leases read are if the tenant is, you know, you think you've signed a 10 year lease. Great, I'm done. I'm going to get 10 years of income for the rest of, you know, all throughout, no risk. Unfortunately, again, market driven. You know, if most times these tenants are going to say, look, I need, if things don't work out, I need a way out of this lease. So they're going to ask for a good guy clause and they're going to say, look, as long as I am current on my lease and I give you six months notice, a year's notice, I want to be able to give you the keys back and you're going to let me off the guarantee and I'm going to be a good guy because I'm not going to, you know, hold over in this space, not pay rent, drag things out for six months or a year while you try to evict me. But the flip side is you're giving me the ability to get out of the lease, you know, at a certain time. So, you know, and look, these are all negotiable, right? So it could be. All right, well, if you want to terminate the lease, you need to reimburse me. I, as the landlord, I just built out a $250,000 installation for you. You got to pay me back for some of that, right? And you're personally guaranteeing. So again, knowing that tenants financial wherewithal, right, is important. Do they have the balance sheet, right, you know, credit check, you know, looking at, if they have other businesses, right. There's also, and it'll be very interesting and for those of you listening to this, you know, podcast, you know, a couple of years from now, a trend to watch and we'll see what is happening is the idea of percentage rents, right? So in big malls, right, where you have publicly traded company retail tenants, they report their sales, right? And these big shopping mall owners say, okay, you're going to pay me a base rent and then you're going to pay me a percentage of your sales, right? So if they are recording all their sales, you know, it's very transparent, Right. Typically in the mom and pop world, smaller spaces, which a lot of our listeners will probably be more dialed into, you know, you never know how your tenant's doing. You know, in fact, the joke is no tenants are ever doing well. Yes, the tenants. Hey, how's business? Oh, it's so tough. You know, business isn't great. Well, hey, there was a line out the door yesterday. You know, why are you slow to pay rent? You know, it's like, you know, tenants are Usually not, you know, telling their landlords how incredibly well things are going in case that they ever need help. But the point is that I think now that a lot of these tenants are gravitating away from cash. That's always, you know, clearly you can't track cash. But if you are doing everything through a point of sale system, and some of these retailers now are completely cashless. So there are systems now. And my friend Jay Norris, who runs Guest G U E S S T and he is on my podcast, you can go back and look for Jay and his partner, Zan Goldberg on how they approach retail and how they structure leases. But what they do is they. They give the ability for mom and pops to report their sales so there can be some flexibility with the landlord. So let's talk about this, okay? Before COVID let's say, you know, tenants paid. I'm a restaurant and I'm paying 15,000amonth for my space. Okay. Now post Covid, I don't know if my business is going to do well. I'm not going to take the risk and pay you 15,000amonth. What I might do is I'll pay you 7,500amonth and I'll pay you 10% of my sales after I hit a certain benchmark and maybe capped at 20,000amonth. So as the landlord, yes, the baseline is less, but I am sharing in some of the upside on the tenant sales. So what Guest does is it actually tracks the sales of that retailer and lets the landlord participate so that, you know, the first thing I said in the show was this is a partnership between landlord and tenant. How much more likely would a tenant be to take the space if they didn't think they had to sign on for full rent day one? If it was like, okay, well, this landlord's going to let me get in at half rent. And hey, if I crush it, then we're both going to win, right? Because I'm going to be doing great business and they're going to be sharing in the upside. So I would take a look at that. And Rachel, I apologize. I can't remember what the original question was, but I hope I answered it. It's just one of those days. It's Friday afternoon.

Like I said, it's all good. I love this method that you mentioned, this flexibility. I think it shows some of these neat trends that are coming in. And the win win can definitely be a good thing all around. I wanted to touch on different markets. So in other episodes, we've talked a little Bit about how primary markets can be different than secondary or tertiary. I'm curious when it comes to leasing, if it tends to be the same, if there are differences we should be aware of?

Yeah, I mean, again, they're all market driven. I mean, that's why it's really important to know what is the landscape. You know, even in office leasing, you know, whether it's a, you know, some office markets, it's triple net, like the tenant pays everything, you know. Now again, it also depends on the type of lease. If one tenant is going to take over the entire building, you know, single tenant, you see a lot of those triple net situations, right. If it's a multiple tenant, you know, profile a tenant. I mean, look, there's going to be a difference if you have a Starbucks or the local cafe, like Starbucks, you know, again, you know, what kind of lease they're getting. You know, their system, Starbucks is probably not going to be the highest payer, you know, because Starbucks knows, hey, you're getting Starbucks credit. You know, we're going to pay and you know, what we're going to deliver and really what we're going to add. Your building like that cool cafe. I don't know why I'm on a cafe kick this afternoon, but you know, again, maybe you want that in your building and hopefully, I mean, that tenant should arguably pay you more for that space. Right. I am taking a risk with going with you because you're a mom and pop tenant, so you got to be willing to pay a little bit more rent because, you know, from the landlord, everybody's hoping they'll be successful, but if they're not, it's the landlord's problem. Right. Whereas Starbucks, I might not get the last dollar, but you know, I'm going to feel more confident that I'm going to get paid. The last thing I really want to stress here from the investors, Rachel, is if your business plan is to tenant a building, then go sell it. We remember we talked about the cap rate and how do we determine what is the type of return that an investor is going to pay for your property? There are so many factors that go into the cap rate, right? First of all, asset class, what kind of building it is. Retail is riskier than multifamily. So you should get a higher return going into retail than multi location, clearly incredible location. Investors are willing to accept a lower return than someplace in the middle of nowhere, right? So you might say, oh, wow, there's this 8, 9% return, you know, way out in the hinterlands and that sounds great. Until the tenant leaves and you find there is no tenants out there who will replace that space. And you know, now, you know, you're stuck with four concrete walls, right? Whereas you know, if you were in a, you know, top 25 MSA, you know, and even the best credit tenants, you know, there's like Radio Shack, like they, you know, things change and they go out of business. So you know, but I would imagine most of those Radio Shacks were probably in very well located areas and maybe it's a Chinese restaurant now, but there is a tenant in most of those locations, right? So again, you know, that cap rate and what kind of return, you know, a lot of factors go in, you know, where is it profile of tenant. And then the thing that I was, that got me off on this kick was the credit of the tenant. So as an investor, you know, if you've got, if you're selling me a building with a CVS Walgreens at the base and apartments above, I'm going to pay, I will accept a lower cap rate. Remember, an inverse relationship between return I will accept and the price I'll pay. If I accept a lower return for a building, I will be paying more money. Whereas if I have that non credit tenant, I'm going to want a higher return because if that tenant blows out again, I've got to go find another tenant. Everybody listen very carefully. I know I've been going on and on, but when you lose a tenant, it is incredibly costly, right? It is. Especially if you have a bad tenant. If they hold over legal costs, you know, landlord, tenant, court. I mean depending on where you are, hopefully it only takes a month or two. In New York it could take a year to get a non paying tenant out. That's really scary. Then you have to go find a tenant, a new tenant. You're going to go market the space. That could be another six months, right? Then it could take, remember that free rent we were talking about? That could be another three to six months, it could be two years to get another paying tenant in there. That's pretty scary. But that is part of the consideration when you think, okay, I'm going with a national tenant versus I'm taking a risk on this new tenant. And that's why going back to my earlier point Rachel, about really trying to qualify and making sure that even if it's not one of the know a publicly traded company, it's an experienced operator where you can point to other success they've had.

Excellent. And I'm glad you brought up that concept of tenants leaving or, you know, causing certain issues that need to be dealt with. I one thing I did want to touch on was, and we've talked in previous shows a lot about construction and renovation, so I'd love to tackle that issue, but with the focus being on the tenant. So if you just want to talk through a little bit about things to keep in mind if we're moving tenants out of a building or if renovation projects typically start actually in vacant buildings, if you want to go through some.

Of those aspects, sure. So again, you know, for like an office type build out, generally it's going to be the landlord who's going to deliver that. And as an owner of a building, there is, you know, to have that control and knowledge that you are building things out in the right way is, you know, on one hand, yes, it's extra work, but you are also controlling the quality and making sure the work is done. On the other way, you know, if you are renting retail, typically the tenant is going to do the build out. Very important that you don't just hand over the keys to the tenant in the space and just assume they're going to do everything by the books. Right. I'm, I have a couple buildings in Brooklyn and one of, I've got a tenant who just took it upon themselves to change the use of the space and you know, you know, do a build out, add a kitchen and they didn't decide to file the, you know, the work. We had to actually go back and make sure, bring in a licensed plumber to make sure that everything was done correctly. Right. So you have to make sure that the tenants are following, you know, are they using a license, you know, architect, licensed plumber, licensed electrician, Are they getting the sign offs? Because guess what, Rachel, if they do it improperly and the city find you, you're the owner. That's your problem. Your problem. Now you can try to go chase the tenant and say, hey, you just because you just did illegal work. I just got socked with this, you know, with this, fine, you got to reimburse me for that. But then you're chasing them for that. So, you know, again, understanding who's doing the work and making sure the work is done properly is very important.

Right. I also want to touch a little bit on the importance of that aspect you brought up earlier of that partnership. So I'm curious if you want to talk a little bit about best practices perhaps between, you know, landlord and tenant or ways that that partnership can actually be very beneficial for Instance, might it mean that the tenant stays much longer than anticipated or not necessarily. Maybe it's market driven, like you mentioned before.

Yeah, Rachel, great point. And look, it is always better to keep your existing tenant, right? Keep them happy and have them stay. Because I just went through, I mean, even if a tenant doesn't hold over and tries to stiff you on the rent, if it's just saying, hey, thanks, but we've outgrown the space, or hey, thanks, but we're going to a better quality building, guess what, you're getting a vacant store back. Now, ideally, you know, the sooner you can find out if a tenant is going to leave your space, you want to use that time to your advantage, right? Go get the space on the market, start trying to lease the space. So as soon as they vacate and give you the key, then you can turn it over to the new tenant. But there's still going to be disruption. Then the free rent kicks in, right? So if you can keep that tenant, you know, that's, that's a really smart way. There's also something Rachel called. And now, you know, for those listeners out there and the 5, 10 years experience and up, you know, something for you as well, you know, the blend and extend. This is a great strategy to add value for property. So let's say you go in and buy a property where a tenant, usually we're talking about a credit national tenant, only has three or four years left, okay? That scares a lot of institutional investors, a lot of passive investors. I don't want a space with only three or four years left. I want to know I have 10 years left. And so generally those spaces that only have three or four years left, I just sold one in Soho at a 9 cap. You'll have to call me and I can tell you that story offline. But the point is, if you can go in there and you buy the space and then you go work with a tenant and say, hey, I realize you've been paying a hundred bucks a foot, right? And when I just again, for the one on one crowd out there, when I say 100 bucks a foot, I'm talking about the total amount of rent that you're paying per year divided by the amount of square footage, okay? So 100 bucks a foot. So look, I understand you signed this lease before, COVID You're at 100 bucks a foot. I get the market's only $80 a foot, right? Now on your lease, you have three years left that you owe me a hundred dollars a foot. What I'm going to do for you is we're going to strike a new 10 year lease and I'm only going to charge you 80 bucks a foot. Now assuming, you know, maybe I bought that deal at a 7 or 8 cap because there was only three years left in the lease. Right. So even though I am taking a lower rent at $80 a foot, I can now turn around and maybe sell that investment for a 5 cap because I will find someone else to buy it who doesn't want to take that, that risk. So you know, let me see how I did on my math. If I take $100 and I divide it by a 7 cap, I've got a value of $1428 a foot. Okay. If I give them $80 a foot, but I sell it at a 5 cap, I'm up to $1600 a foot. So I just added value taking a lower rent. Right. Does that make sense?

It does. And I love that example. I think it shows how you can do so many different things with a space and change that value after coming in. And a lot of it depends on that partnership, you know, how you're working with the tenant and what's going on. It's that give and take. So this is great. Anything that we want to talk about when it comes to vacancy rates? I know we talked about tenants moving in and out. I guess from a financial standpoint, if you know when you're getting a property, if a vacancy rate should be a sign of alarm, not necessarily. What are going rates for vacancy rates perhaps. And if that depends on the market.

Got it. So, and I'm trying to remember when we did the show with Derek Aiken, if he kind of broke down how you factor top line gross revenue and then the egi, which is the effective gross income. So what I'm doing is I'm taking a top line which is the rent that you're paying me. And then again, when you're underwriting a deal, you are assuming that there's going to be, it's VNC vacancy and credit loss. So if I'm only, you know, I'm going to get some turnover. Right. And this happens in all buildings now in a residential building in a really tight market where a tenant goes out and you can re rent it a week later, you know, your vacancy and credit loss might only be 3%. Right. Go to the far into the extreme, you might be going into an office market where there's 20% vacancy. Right. And your building may never be, you know, you can sit there and project and say, hey, wouldn't it be great if I could fill this whole building up and get these rents? Well, hey, that might just not be the market. And it's not just vacancy, but it's also credit loss, credit losses when that tenant doesn't pay. And now you lose that rent and then you know, an expense that we typically do not put in a broker's setup, which is that legal expense, you know, how much am I going to have to pay an attorney now to go help me vacate that tenant? So yes, that really depends on the type of real estate we're talking about. The location. Right. You know, so market driven. But yeah, you need to factor that in that it's not like you're going to get every single penny of revenue that, that, you know, the leases that you're present to, I mean that also includes the concessions. If I give free rent, you know, I am, you know, losing whether it's two, three months of rent. Now that could be a one shot deal, right. Where I had to give someone free rent to get into it, right. But if I am figuring out what I'm going to pay for this building and I know I've got vacant retail, the way I'm going to project this, and this is, you know, back of the envelope is okay, this is what the full rent is for the building as if the retail is rented at market, right. Minus my vacancy and credit loss, you know, in a typical market, let's call it 5% minus the expenses, net operating income divided by the cap rate equals my investment value minus the concessions to get there. So minus the brokerage fee, minus the downtime, minus the construction cost down below. And again in the book we're going to have tables, you'll be able to see this all I know, hopefully you all are listening and this is, you know, you're following. I'm getting to my revised investment value. That's my snapshot. So for me to get to a 6% return, I am going to use that projected rent. But then I'm gonna have to factor the expenses, those one time expenses it's going to take me to get to there. That's also by the way where I put capital cap X. Like if I've got to replace the roof, I got to replace the boiler. That is coming out of my snapshot number. If there's ongoing repairs and I think we talked about this the last show, I'll put that in my repairs number in the managing, you know, the management number. So again, I know I'm Kind of, you know, going off on a tangent here, but. But hopefully to help kind of paint the whole picture here.

Yeah, it helps keep it real. I appreciate the breakdown and I think it's important to think all that through as you're going in. So I think for my last question, I might ask. We've talked about so many different aspects with leases. I don't know if to summarize, perhaps you have what you would consider best practices or key takeaways that you would love listeners to remember from this very topic, Tenants and leasing.

I think it goes back to some of the early principles, having that right team, especially if you're doing this the first time, you really need to make sure that you've got a great broker advising you, great counsel to make sure you're structuring these things in the right way. And you really have someone who can help you understand the financial wherewithal and ability of that tenant. You are making a bet on that tenant and understanding, like you want them to be successful, but you need to understand and, you know, look, sometimes it's a trade off. Maybe you want to give that aspiring entrepreneur a shot and, you know, they should be paying you a premium rent to, you know, to compensate for that. But I think really, this is not something where, you know, you just kind of sit back and you just look at the numbers like, you got to speak to these tenants. You got to understand, you know, hey, tell me about your business, tell me about your plan, what it, you know, really get to know them, right. And, you know, make sure that you are asking the right questions so you're not going into these situations blindly. Perfect.

Great thoughts. And so to wrap up, I'd love it if you could leave us with a podcast or maybe an example that we could go to that helps us learn more about this topic. I know you mentioned one. I'm curious if there's others we can go to.

Yeah, I'm trying to. Pretty much every single episode I do. If you're talking to investors, you know, the key piece is the business plan and how you're finding the tenant. I don't know if I've recommended Ian Ross yet from Samara Road. You know, the title of that episode is know your market. And you know, Ian, I mean, he's, if I'm not mistaken, he's still, you know, in his 30s. And this guy is just, I mean, what they have built up, you know, dozens and dozens, hundred, you know, if not hundreds of properties. And they are going into these markets and they need to Understand the landscape of these markets. They are competing with local investors who've been watching that market for 10 years. And I think, if memory serves me, one of the questions I asked is like, Ian, how do you figure out these markets? How do you understand? And what I'm asking is like, what are the drivers? Who are the tenants? Right? Like, because one thing we didn't even talk about in the show is like, okay, well, where, you know, what are the drivers, who are the big companies? Just because you own a little building, you know, if you're next to Google, that's obviously a great thing because they got tons of employees and they need to go to cafes. And there I go on that cafe kick again. But, you know, understanding what are the drivers, what are the market conditions? And if I'm not mistaken, I said, you know, Ian, how do you buy in these markets that you've never been to? He's like, it's easy, you know. And I, he said, I know there's markets that are one day markets and there's days that are, you know, there's cities that are three day markets. A one day market. I can go in and with one day meeting with leasing brokers, you know, attorneys, whatever it is, I can figure out everything I need to know. Not going to know everything, but enough that I can make an investment where, if it's a bigger market, like New York is a super complicated market. It is a massive market. I would say it probably is going to take weeks, if not months to figure out, but depending on where you're looking, like you have to go in and study and understand what are the market drivers.

Perfect. That's great advice and definitely a good show to listen to. So that's where we'll leave it with this topic. Our next show will actually talk about the final step, which is all about what to do next. So thoughts on the sale? Refinancing, building up that performance portfolio?

Rachel, you're getting me really sad here. Are you saying we are actually getting like to the end of this, you know, after next show, then, you know, that's it. I don't know, we're going to have to figure out the next project, you know, to work on or we'll have to start making up chapters so we can, we can keep the conversation going. But yeah, you know, it can't go on forever. And you know, look, we're, we really think that after We've covered these 10 steps in the introduction and why real estate? And then we'll bring it all together, you know, we really. And Rachel, you said earlier to give you everything you need to know to have that inside edge to real estate investing. That's what we're doing here. So I want to thank everybody, as always, for listening. It means so much and especially for those of you who are sharing the show and telling your friends. And that's what we're trying to do. We're just trying to help educate people out there. This information, it just, you know, again, before this, this was all just stuck in my head. So, you know, somehow to get this out, to get it out on paper, to make it accessible, that's what we want to do. So hopefully we're accomplishing that. And if you agree, please subscribe. Please leave your rating. Please send your comments. Connect with me at James Nelson NYC. Check out the website james nelson.com so that's it until next week when we're step 10. We, you know that that's it. We're talking about the big capital event and how to reap the rewards for all your hard work work. So make sure to tune in next week as well. Thank you again everybody.

Thank you for listening to the Insider's Edge to Real estate Investing. We appreciate your subscribing and sharing with your friends. If you haven't already, please connect with James Amesnelson NYC on LinkedIn, Instagram and Twitter. Please also visit jamesnelson.com where you can find the show, notes and other applications, episodes, along with an exclusive video series and other helpful resources so you can gain the Insider's Edge to real estate investing. Until next week.