RES 173 | Commercial Real Estate

 

There’s no greater feeling in the real estate world than when you finally close a deal. Among all the listings in real estate, retail properties are perhaps the most challenging to get a deal done. As tough as it may appear, commercial real estate is still one of the big shots. Sean Katona, Managing Partner in Simplified Properties, walks us through his journey when he switched gears from flipping business to leasing and getting vacancies filled up. A full-time real estate investor, he reveals why he is more interested in service-centric tenants and adding value to properties. Discover the things to take on when underwriting and executing deals, the importance of having mentors in real estate business, and the secret sauce to Sean’s success.

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Sean Katona on Adding Value To Commercial Real Estate

Our guest is Sean Katona. Sean is a full-time real estate investor, landlord and national speaker. He owns income property across four states and has spearheaded 70-plus deals ranging from value-add renovations to new construction. His focus is revitalizing the retail shopping centers and apartment buildings to maximize returns for friends and family. Sean, thanks for your time and being on the show. Tell the audience a little more about who you are and what you’re doing or focused on.

I got started in real estate all the way back in 2009. I was working at Microsoft at the time and had been able to save up enough money that I thought, “Let’s go grab a rental property.” I did that and I fumbled my way through a couple of deals. I got into the fix and flip space. I got into rental houses and did that for a few years. In 2013, I went full-time at that. I have a good variety of projects, everything from wholesale projects to new construction, a lot of fix and flip. That’s been focused on commercial properties. Apartment buildings and shopping centers are basically my favorite category. Most of my business that I’m working on is happening in Phoenix. I live in Orange County, but I do business a 90-minute flight away, so it’s possible to do day trips but still get good returns.

Can you talk a little bit about the transition from the flipping business to what you’re doing or even just why and how did you do that?

I just didn’t know commercial real estate or investing even existed when I was growing up. I didn’t come from a family with tremendous wealth and I wasn’t surrounded by people who did the business at that level, so it’s where it got started. It’s what you saw on TV and it’s what I knew. I took a run at that and I think it was helpful. I got to learn a lot of lessons the hard way maybe in deals that had a fewer zero and one less comma behind them, so you learn the ropes of real estate, the fundamentals. As we started to shift gears into bigger projects, it was great to have that resume to point to and that deal history and just understanding how to do things like force appreciation, managed construction projects, managed debt, managed equities. A lot of the things that are relevant for commercial, we’re also utilized on the residential and the single-family side of the business.

What inspired me to steer the ship or switch gears is once you start to see the numbers on the bigger deals, it comes down to opportunity costs. We’ve only got so many hours in the day. I’d rather do five or ten smaller deals or one higher-quality bigger deal that has more tax advantages and has the potential for more cashflow. You’re not spending as much time managing and grinding on some of the details that can come along with it. At one point, I had about fifteen flips going simultaneously, and that was a lot of construction to manage and a lot of personalities and personnel to manage. For those of us who have done that, I’m sure they can appreciate some of that.

What was the key to moving from that business to going into a commercial? Give us one or two things that you’ve got to have in place.

It was invaluable that I’d already had experience raising capital both debt and equity, so I understood how to communicate that to people. I knew how to talk to bankers. I knew how to source quality deals. I knew that I probably look at 100 deals and pass on 99 of those to by one high-quality deal. That’s very similar from residential to commercial. We’re working through agents, through brokers to find good deals, but not all of them make sense for our buying criteria. What’s been consistent throughout my career is finding value add projects. Either fixer-upper houses or fixer-up for shopping centers or buildings are typically what I’m hunting for when we’re going out and looking at deals.

The tech and the tools are getting so good that you can let the data drive a lot of your decisions. Click To Tweet

The flipping business taught you some critical skills that have helped you in the syndication business or a commercial business, correct?

Without a doubt. Although, sometimes I wonder if I’d skipped that and just gone straight into a number of commercial properties, I would be even further along or have that many more deals in the portfolio. It’s hard to say. I have no sense in necessarily go in hindsight 20/20 on that. It’s a fascinating thing if you’re going to hit the reset button, I don’t know that I would have done all those single-family deals. Certainly, I would have gotten into commercial a lot sooner than I did.

Why retail shopping centers? There are many asset classes and commercial, so why that one?

One of my most awesome mentors who’s become a good friend, that is certainly a category that he has a strong affinity for. I ended up seeing a lot of case studies and deals where we bought it in this condition. We were able to take it here in a relatively short period of time. I saw how that worked over and over again on retail. I’d love to own more units. I do find that there seems to be a shortage of quality deals that have that value-add component. I will plan to buy more and more apartment units over time. With retail, it seems there’s a little bit of doom and gloom out there if you read the headlines or in the media you’ve got Sears and JCPenney and all these historical retailers struggling or maybe reinventing themselves. Maybe it’s a little less competitive of a food group than let’s say multifamily apartment, which I think almost every real estate investor can grasp and can understand, so there might be a little bit less competition in retail.

I love the type of product where it’s service-centric. It’s not going to get cannibalized by Amazon or eCommerce. It’s people who are taking their dogs to get groomed, they’re getting haircuts. It’s the service-centric neighborhood tenant that I tend to focus on because for me that just feels a little bit safer to go after in a landscape of changing retail. One of the things that I’ve just come to appreciate is when we do a deal in retail with the tenant, all the work is front-loaded and then we can sign a five, seven, ten-year lease that locks in our income stream for however long it is. After that, the tenants are relatively low maintenance, let’s say compared to single-family or multifamily tenants where you have to have a property manager onsite at all times to take care of all the little things that come up just with that type of tenant base.

The service-centric tenants like you were talking about, could you give us some examples of those, so when people are thinking about going into retail, they understand what type of tenant that is?

It’s pretty hard to buy your hot cup of coffee online. Starbucks would be an amazing tenant to have. In my shopping centers, it tends to be more mom and pop tenants. It’s folks who have a couple of locations or maybe it’s their single location and they’re going in there five days a week and they’re grinding it out. If I think down my tenant roster, it’s a dance studio and it’s a dog groomer and it’s a couple of barbershops. It’s the local electrical company. It’s the local water company. It is an insurance agent. It’s a restaurant, a bar and a grill. It’s a guy making Mediterranean dishes. It’s stuff that people are frequently coming back for that generally isn’t getting attacked with the eCommerce model. It’s service-centric, you might say, or your brokers would say internet-resistant. That resonates with a lot of buyers and owners of a property.

RES 173 | Commercial Real Estate

Commercial Real Estate: In an ideal world, we always have the tenant signed and committed to a deal because then we’re not risking dollars that may not otherwise come to fruition.

 

I like that internet resistant and I like the model. You said it’s hard to buy a cup of coffee on your smartphone or make it appear anyway. As far as in retail, what are some of the things that we wouldn’t even know to think about? Coming from multifamily or a single-family, what else should I be thinking about when I’m thinking, “I’m going to focus on retail shopping centers?”

We’ve all heard in real estate, “It’s location.” Maybe it’s more important in retail than in any other asset class because when you’re talking to the class A retailers of the world, they know their numbers inside and out. They can go, “Based on the demographics in a one, three, five-mile radius, the number of cars that are passing by on the road in front of the shopping center, given the good visibility that we have of the shop space, we know we’re going to sell X cups of coffee,” or X amount of Subway sandwiches, whatever that product is. They know their numbers inside and out. If you have a B or a C quality location, it doesn’t mean you can’t fill up those buildings or lease them up, but you’re probably going to land that type of tenant. Starbucks is very particular with the type of site that they would select and where they want to locate and who their neighbors are. You don’t necessarily have all of those same factors, at least in single-family, multifamily. An office user may not care as much and probably even less so in an industrial warehouse or something along those lines.

Could you tell us about maybe the deal that you all have closed down?

We just hit our 100-day mark on a new property in Phoenix. It’s in a suburb called Goodyear. We’re about 100 days in and we’ve got some good momentum you could say. It happened, unfortunately, a little bit faster than I was expecting, but we have a number of leases that have been renewed with existing tenants there. We have a couple of new deals that have been signed. Another deal is pending and we’re just starting the construction on some of the gray shell space that exists in the building. When it was originally built, they never built it out for a tenant, and that’s how we’re adding a lot of the value of the property. We’re going to spec out the suites. We’re going to build them to suit a barber or a classroom type user or a gym user or a physical therapist. All those types of users that would love to locate here but don’t have the space built out yet. That one’s definitely top of mind.

It’s unique in that we’ve got 16,000 feet of shop space, but we also have a pad site in front of that building where we could do a deal with a Starbucks potentially or a Chipotle or maybe an In-N-Out with a drive through there and they’re on separate parcels. It gives us some unique opportunities to ground-lease the dirt, to build to suit where we strike a deal with those users. It could end up being a multitenant configuration where you put maybe two or three users in a single building that’s 3,000, to 5,000 feet. That’s another exciting way to be able to add value to that property through strategies where we can force appreciation to do some construction, get some deals put together, and then do the cap rate valuation on what tenants like that in this neighborhood would trade at in the market.

You were talking about building out that space that is 16,000 square feet, that’s pretty massive. Are you going to be building those? You’re talking about whether it’s for physical therapy or a gym, you named off different things. Will you have the tenant in place before you build those or are you going to build it and hope they come?

In an ideal world, we always have the tenant signed and committed to a deal because then we’re not risking dollars that may not otherwise come to fruition. The flip side of that argument is a lot of mom and pop users or tenants have a hard time visualizing the space or they’re moving fast and so they don’t have a three to six-month lead time to go ahead and get it built out and get all the plans done and get the permits. They want to move that next month. With the second gen space, it’s already built out. If a former user was already in it, they could move that much faster. I was fortunate in that as we started to go through the process of specking out these suites for who knows who, we actually had a couple of deals come to fruition.

If you're going to go out and attempt your first deal, assemble the Jedi council – have coaches and have mentors. Click To Tweet

We can make a slight adjustment to our configuration and say, “This is going to be perfectly suited for a barber. This will be perfectly suited for a physical therapist.” As we’re going through that permit and build out process, they can make some of the adjustments and say, “This is the flooring that I want.” Do you want your ceilings open concept or do you like the close grid style? They can have a little bit of feedback along the way. With different tenants, they might say, “This is exactly what we need to be built.” The landlord takes on all of those costs. In some cases, the tenant can take on a lot of those costs. There are a lot of different ways that it can be done. You talk to different guys who have had different experiences with their buildings or their areas and they’ll tell you their preference and why. Maybe I’m a hybrid of those two, just given how these deals are coming together.

It sounds like in the commercial or retail space, especially the projects you’re talking about, you have to have a good imagination and you have to be good at visualizing what this building could be. It’s not like buying a multifamily property. You’ve got to still be creative. If there are other opportunities on a multifamily property sometimes at other people haven’t seen. However, with that one, it’s anything you want it to be.

It comes in a lot of shapes and sizes too. Some people, when they think of retail, it’s like, “Here’s a piece of dirt that we could build an In-N-Out Burger or a McDonald’s on,” and that’s where the deal gets done and it struck and McDonald’s takes care of everything. On another deal I had, every suite was built out and it was a matter of changing out some of the tenants, renewing some of the leases that had burned off, upgrading some of the tenants or bringing in people who can pay market rent where other tenants were paying less than market rent. Understanding what would be the highest and best use for either that box or that building or that neighborhood that’s going to benefit the people in that community, but also be great for the owners of the building, the investors in the building, the lender who has the note on the property. You have to be thinking about all of those things as you’re underwriting deals and then executing on them.

I appreciate what you just said too, understanding the highest and best use for that property that’s going to benefit the community and everybody involved. I would imagine that it takes some skill. How do you know you’re accomplishing that?

What’s nice is that the tech and the tools are getting so good that you can let the data drive a lot of your decisions. Not on this current deal that I just mentioned but the one prior. We knew that there was quite a bit of spending happening or leakage as they say in retail outside of the city. People were buying their groceries and their goods and their services up the road on their commute in and out of the property. In this case, we go to a retailer and say, “If you opened up a store here, here’s the data that supports how much consumers in a one, three, five-mile radius are spending on these goods and services.” You can almost reverse engineer the best fit for it, just looking at some of those data, the demographic trends and then how the spend is happening in those areas. The same goes with site selection or buying another building. I talked to my brokers in Phoenix, everyone says, “One of the hottest categories is food users.” There’s a bunch of new restaurants opening and their favorite thing is second gen restaurant space, so they can just come in, retrofit it and they’re operational in a relatively short period of time for maybe fewer dollars being spent than a brand new ground-up build that takes however long it takes that builder to do it.

Sean, you got one minute with somebody that’s brand new and they ask you, “Sean, I want to get into this syndication business, maybe retail, maybe not, I’m not sure.” What do you tell them?

If you’re going to go out and attempt your first deal, I would certainly assemble the Jedi council. I’ll have coaches and mentors. I invest with other people who have thousands of units in their portfolio so I can see how they’re running and operating their business. What a great way to learn from the inside. You have all of our vendors that help us to make sure we’re doing this right, that nothing slips through the cracks. I have attorneys do all of the legal work. I have property inspectors looking at all that. I have professional leasing agents helping with our lease up. We have licensed general contractors who are doing the building, architects who are putting all that together.

RES 173 | Commercial Real Estate

Commercial Real Estate: In the commercial world, all the profit, the cashflow, and the tax savings are a little bit bigger than on single-family and residential.

 

It’s nice because in the commercial world, all the profit, the cashflow, the tax savings are a little bit bigger than my experience on single-family and residential. We can afford to put high-quality resources, vendors and talented folks on as members of the team or at least vendors to help execute all that. I’d say, don’t just wing it on a deal of this size. When you’re talking about multimillion-dollar transactions, we can’t afford any mistakes as we want to get it right the first time. When we do that, it can create some unique opportunities just with a single transaction.

How did you find your mentor?

It was through a referral. I had one set of mentors that taught me the house flipping part of the business. I sought out another mentor who was a specialist in commercial and multifamily, then over time, I started networking with folks who do that as their core business. You meet them at a mastermind group or a real estate get together. You’re going out talking to brokers. Now, in the case of retail, there is a pretty great convention. It’s like an industry group, ICSC, International Council of Shopping Centers, owners, brokers, property managers, and everyone gets together once a year in Vegas. About 35,000 some odd people are talking about what they’re doing and they’re working on leasing and they’re working on buying and they’re working on selling. It’s a great place to meet people who do the business full-time. I actually landed our last deal there in Vegas. I sat down with the broker, talked to her about what are buying criteria was and she goes, “I’ve got one. It’s off-market. I’ve been leasing it. It’s got some vacancy. It has some build out that needs to be done. Would you like to take a look at it?” Sure enough, we ended up buying that deal. That’s worked out well, and she continues to help with leasing and might even be taking the relisting assignment on the back end if we decide to sell it down the road.

What’s been the hardest part for you, the retail or the large commercial business?

The speed. In a single-family or even a rental house or probably even apartments, it doesn’t take that long to get a deal done. You sign a lease, you fill up some units, you buy the house, you fix the house, you sell the house. Retail things move to me a little bit slower. It might be six months to fill up a vacancy. It could be for nine months. People who are doing ground-up development might spend well over a year on a project getting it out of the ground and waiting for those leases to get signed. When you’re working with some of the retailers, let’s say, they are a little bit more methodical going through it. It’s got to go up to the powers that will be at corporate. Their legal team reviews it. Their site manager reviews it. It comes back through the brokers. There are rounds of revisions and all of a sudden, a couple of weeks or months has gone by in order to get a single deal done. That one deal can be worth hundreds of thousands or even millions of dollars of profit, depending on the size of the scope, the scale and the length of the lease.

I can imagine. That’s where some experience or some skills going to come into play when you’re going to be accounting on a six-month vacancy or a year vacancy, that would be hard to plan for if you didn’t expect that.

I think that’s what someone’s got to do going into a deal, especially if it’s their first one. Assume that that’s going to take a period of time. Fortunately, we can look at some of the data and say, “In this area, at this price point, with this type of asset, historically it’s taking nine to twelve months to get one of these vacancies filled up, the absorption.” We can look at that, we can underwrite some of that into it and say, “How does this deal look if we don’t fill it for twelve months?” It still cashflow, it still makes sense. When it does, what price point is that deal going to get struck at?

Surround yourself with a star-studded cast to support what it is that you are working on. Click To Tweet

What’s a way that you’ve improved your business that we can apply to ours?

For me, I think so much about the buildings specifically. It’s that on a day-to-day or week by week basis. We renewed a tenant. They’re going to stay another five years and their rate went up 5% or 10%. That then trickles down to the NOI. That increases our cashflow. That increases the value of the building by a pretty specific amount that we can measure, so I can look at that on paper and say to my investors, “Here’s what we’ve been able to accomplish in Q1 of 2019,” or I can turn to my wife and I can say, “Here’s how much more cashflow we have coming in based on the last deal or two that we’ve done.” That’s real and that’s tangible but that’s in this business. Leasing and getting the vacancies filled up, which is what I work on. I buy fixer-upper buildings that have something inherently wrong with them, so we can go in and solve that problem and then force the appreciation into the property. That’s on a deal basis.

As I reflect back, maybe it ties into surrounding ourselves with a star-studded cast to support what it is that we’re working on. It doesn’t take a huge staff necessarily. We can use third-party property management, vendors, contractors and architects who can help us do a lot of the heavy lifting so that we do the one thing that we do best. I find deals, I forge relationships with brokers and then I give my friends and my family the opportunity to do deals that would not otherwise be accessible to a layperson. These are folks that are going out and they’re busy, they’re working their job, but they get to invest in a deal that has in my case, much higher returns than what I was able to accomplish in the single-family world or as an individual investor where you maybe don’t have the economies of scale that we can get in some of the bigger transactions.

What’s the number one thing that’s contributed to your success?

It’s probably having help. I’m not a sharp cookie. I don’t have a ton of experience doing these deals, but I was able to align myself with people that did and do, and the same goes with the supporting cast of folks. My tax guy is a wizard. My brokers that I work with are some of the most experienced and seasoned guys in town. They’ve got decades of experience. They’ve resold some buildings two or three times and so they can just tell you the history of that corner in town, and that helps me fill in all the gaps that I have and there are plenty of those.

What are you excited about for the future of your business?

It’s the continued growth in what we’re doing. I certainly experienced that as you switched from residential to commercial or make that transition, there’s a whole different learning curve and you’re reestablishing yourself with different brokers potentially in a different market. Lenders might look at things a little bit differently. As you knock out that first, second, third deal, the subsequent ones just become so much smoother. You get to look at properties from the inside. Brokers are bringing you things that are off-market before they list it. Another one of your guests and a gentleman that I respect talk about this is an imperfect market and it’s unfair. I’ve got an inside track on deals that other people just won’t know about unless they have an existing relationship.

RES 173 | Commercial Real Estate

Commercial Real Estate: As you knock out that first, that second, and that third deal, the subsequent ones become so much smoother.

 

The reason the brokers are bringing it to us is that he knows he’s going to get the relisting on the back end if we sell it. He knows that I’m going to use his team to do the leasing. He knows that we’ll allow them to double end it so that they can make more commissions. That’s all kosher in commercial real estate and you’re trading favors to get some of these deals done. It makes sense for them. It makes sense for us. It makes sense for our investors that are participating in it and for doing that right, we can put some pretty exciting deals together.

Is there a need in your business that you’d like to let the audience know about?

I love to have more deals. That would be targeted at any commercial real estate brokers who read this blog. I’m always open to new introductions when it comes to folks who want to invest. Historically, that’s always been friends and family. I prefer that but folks make introductions to each other and they go, “This is the reason why we love being a part of commercial syndications. We get the cashflow, we get someone paying down our loan, we have the depreciation, we have the appreciation on the building. Frankly, we don’t have to do a lot of the heavy lifting.” You’ve got a sponsor or someone who’s putting these deals together, doing a lot of that legwork for you and they’re just able to make money with us. I love that our interests are aligned. When you think about a sponsor or investors in the deal or a GP and an LP coming together, we get paid when they get paid. I think that’s a set up that makes it a lot of sense.

How do you like to give back?

I’m big in people getting the skills and the opportunity to go out and help themselves. It’s teaching a man to fish. I spent a lot of time over the last couple of years teaching other real estate investors how to do this business, both residential and a little bit on the commercial side as that started to grow more and more in our portfolio. I love doing things that support the kids. We’ve been supportive of things like junior achievement and things that give kids a head start. We’ve got an eighteen-month-old and a little girl on the way. What is it going to be like for them to grow up in a household where they’re seeing this type of business or portfolio managed and what their norm will be set up? If we can expose more and more kids to that, it’s a pretty special thing. I know you do some cool things with your program as well.

Sean, thank you so much for being on the show. I appreciate your time and the value you provided about the retail industry all together that so many of us are not as familiar with. It’s good to learn all this from you. Can you tell the audience how they can get in touch with you?

The best way is to go through the website, SimplifiedProperties.com. I’m on LinkedIn, I’m on Facebook, I’m on Instagram. If you Google me, I pop right up too but that’s got all the contact information, email. You can book appointments on my calendar right from there too and get a little bit more background about some of our projects, what we do and what we expect to have come in.

Thanks again and I hope the audience will reach out to you. I appreciate the audience being with us. I hope you’re going to LifeBridgeCapital.com and connect with us. Also go to the Facebook group, The Real Estate Syndication Show where we can all learn from experts like Sean and grow our business together.

Thanks, Whitney. Take care.

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About Sean Katona

RES 173 | Commercial Real EstateSimplified Properties is a privately held real estate investment firm founded by Sean Katona.  We buy underperforming centers and transform them to maximize potential. Sean is a full-time real estate investor, landlord and national speaker.  Katona owns income property across four states and has spearheaded 70+ deals ranging from value-add renovations to new construction. Today his focus is revitalizing retail shopping centers and apartment buildings to maximize returns for friends & family.

Prior to real estate, Sean spent 7+ years selling advertising solutions to Fortune 500 companies.  At Microsoft and EA Sports Katona drove alliances with some of the world’s best-known marketers including Paramount, Warner Bros, Fox, Sony, ABC, NBC, Kia, Hyundai, Toyota, Mazda, and Dr Pepper.   He holds a bachelor’s degree in Business Administration with Sales, Marketing & Information Systems concentrations from the Foster School of Business at the University of Washington.

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