There are a number of mistakes new investors make when first stepping into the world of commercial real estate investment. Whether triple net property investments, multifamily property investments, or any other form of commercial investment, the same drive that drew you to the industry in the first place could be the source of your first crucial mistakes. Peter Von Der Ahe has completed billions of dollars in commercial real estate deals throughout more than twenty years, and he shares his insight into triple net real estate, multifamily investments, where the industry is headed, and what it takes to become successful in real estate brokerage long-term.
Richard Wilson: Hello everybody, this is Richard C. Wilson, The Family Office Club, and CommercialRealEstate.com, and today we’re going to go through 20 question and answers with Peter Von Der Ahe, who is an expert on multifamily and triple net real estate. Welcome, Peter.
Peter Von Der Ahe: Hey, thanks Richard. Looking forward to having this conversation.
Richard: Sure. So we’ve gotten to know each other over the past couple years, and I know that you have complete over a billion dollars a year of commercial real estate deals over the last several years in a row, and the point of this interview will be really to knock out a lot of questions we get related to triple net and multifamily properties. This will be a good video for someone who is really looking to, maybe, invest in triple net, but they really don’t even know the basics of it, or people that have a lot of questions about it because they heard it’s tax efficient, or they’ve heard it can be better than investing in other types of retail assets, or office parks, etc. So, I appreciate you doing this. So, to begin with what is triple net real estate?
Peter: Well, net leased properties are essentially, it’s any type of investment real estate where the tenant has basically entered into a lease with the owner of the real estate itself and in that lease it says they are going to pay you rent and operate the property. As far as the economics of the cash flows go, your operations are net of any real estate tax expense, insurance expense, or any operating costs. In the true, pure, triple net definition that would include every, you know, any maintenance or operating of a property.
Peter: When you get into these properties, there’s a lot of nuance and all those nuances are actually explained and need to be further researched in the lease. Because when you get into this, there’s triple net, there’s double net, you know, and everything in between. There’s a whole lot of kind of slang terms that people use in the industry, sometimes correctly and sometimes incorrectly, so if you start with the purest this is a piece of real estate that is leased to a tenant that takes care of all the operations and all the expenses and all you get is one net rental check and then there’s everything in between.
Richard: Right. Right, okay, makes sense. If you’re talking about how it differs if someone says triple net versus double net is that usually the taxes that are left in? Is that usually the difference in shorthand, when people are talking about it? Or can it mean all different types of things?
Peter: It can mean all different types of things. Generally, what we’ll see is that the biggest difference will involve some type of capital items. So, meaning that the tenant will be responsible for most of the maintenance. However, if something happens to the roof, or something happens to the structure, there may be some type of calculation that determines the economics of when the owner would have to step in and contribute to the remedy of that. A lot of the times that this comes in, and where you have to look at the language, is toward the end of the lease term. Because off the rack, many of these properties have 20 year leases, but then in the lease clauses themselves some of the details that we’re talking about are elective to the economics of who’s responsible for what. That may change in years 18, 19, and 20, and so those are just little details that you need to explore as you enter into this investment type.
Richard: Sure, okay, great. Are there any tax advantages to investing in triple net real estate versus other types?
Peter: In general, I think there are 3 or 4 major tax advantages for investing directly in commercial real estate itself. Just quickly, one is the 1031 exchange, the other is being able to use depreciation, the other is being able to write off your interest expense when you get a loan. As far as the special tax characteristics, some types of real estate qualify for bonus and accelerated depreciation, which allow you to shelter more cash flow, and if you have cash flow from other investment real estate it may carry over and shelter that cash flow as well. So, we see this mostly when you’re selecting certain types of assets that have accelerated depreciation. And then if you combine them with something called a cost segregation study, that’s where you get a real pop in terms of the depreciation benefit.
Richard: Sure, okay. You’ve seen hundreds of triple net properties, so what valuation, best practices can you share on triple net commercial real estate?
Peter: The valuation best practices there are so many, there are a couple of different factors, you’ve got the tenant, you’ve got the location, you have the credit of the tenant, and then you have the what we would call the unit economics, which is how is the actual economic performance at that location. Finally, the cap rate and the financial metrics that you’re actually purchasing the property at, and what the lease term is, what the increases are, and how those are calculated and all that kind of stuff. So, those are all, those are about the 4 or 5 main dials that you would use to evaluate any net lease investment. Most of the time what you’ll see is that not all 4 will rate a 10 out of 10. It’s up to the individual investor themselves to figure out what they’re comfortable with.
To make an extreme example, some people may be comfortable with a very poor location but a very, very high quality tenant where the asset or the business in that location is performing very well and you get a better cap rate. As opposed to you could be in the middle of a metropolitan, the middle of a city, on a main on main location where the location is out of sight but that’s going to be priced very high and in that case, because you’ve got all the demand drivers, you may be less concerned about the credit of the tenant. That becomes a very personal decision in terms of what your objectives are.
So if you’re – the way we get into this and the way I really entered into this type of advisory part of the business is you have a couple demographic shifts happening in the country where you have massive amounts of real estate owners who have held management intensive real estate for 10, 20, 30, you know, 40, sometimes generations of years. They get to a point in their life where I heard one say the phrase to me “It’s nice to own a lot of real estate, but almost feel like the real estate owns me.” And so, one of the motivations for investing in this type of asset class is to begin to lessen your management load, take advantage of the 1031 exchange tax deferral, and in many cases your cash flow increases. So, the combo of those two things is a very nice solution for people. Not to mention the diversification and, there’s a whole other – that’s a whole other category that we can talk about for an hour. And you know we’re talking about this, we’re having this conversation in Coronavirus time, and if every investor and every asset class hasn’t learned the benefits of diversification you’ve really got a lesson in it now depending on how all of your investments have been performing over the past 6 through 8 months.
Richard: Right, right, so if I’m understanding right it’s almost like it allows you to be a little more passive of an investor with triple net versus if you own an office park or multi-family property, right?
Peter: Yeah, that’s exactly part of it, and that’s one of the main drivers is that there’s less day to day execution risk. If you had to be very, you know, kind of like the negative stereotype is “Oh, this is, this asset class you’re just buying a bond and they’re bad investments…” but when you get into the, just like anything, when you learn more about it and you explore the asset class further, there’s a whole bunch of triggers and ways to add value that are all dependent on how you structure things, how the location develops what’s happening with the tenant, the increases, the rental increases, are structured, and a lot of it has to do with financing and the lease terms. So, I would say that there is in these type of assets there’s less day to day management, obviously, but that doesn’t mean that it’s completely devoid of any type of strategy.
Richard: Right, right, yeah, makes sense. Why is it that triple net commercial properties are often nationally traded versus more locally or regionally traded?
Peter: Probably the single biggest driver for certain investors with these is the credit of the tenant, so if you have a national publicly traded company that is standing behind the lease your rental payments are not dependent on performance of the one location that you’re buying. Your rental payments are guaranteed by a company, and in this example that we’re talking about, in theory you’re backed by a company that has many locations across the country. So, that’s worth something. If you are entering into a retirement phase of your life, where you want to have less day to day management, your main drivers are “I want income security, and I want consistency, and I actually don’t want surprises, either on the positive or the negative.”
It’s actually more important to you to just have a steady stream of cash flow. So that’s why you see many of the brands that fall into that triple net category that are national. When you get into this, I’ll just add, this is also another area of this asset type where you have to look at the lease because you have to look at who’s actually standing behind the credit. Sometimes there are franchisees that may be a national brand, but you may not be getting national credit, and so on and so forth. So you have to work with experts who really know that space and part of the assembling of your investment team, which is accountants who know about this, attorneys who specialize in this, and then also from the investment world, brokers and what have you.
Richard: Sure, makes sense. So, based on your experience, what are a couple of strategies that an inexperienced triple net investor would take? You kind of hinted earlier about how maybe going after very high credit but maybe what would be considered a bad location might get you a better cap rate and your downside is really limited by the fact that it’s based on a credit of this firm as long as it’s not by a local franchisee – that sounds like one strategy an investor could keep in mind. Is there another strategy or two related to this area that could be helpful to the investors listening?
Peter: Yeah, and I guess I would put the first thing out there, that’s kind of a mindset that I think a lot of, that I see investors go through is a lot of investors show up initially and they think all their money has to be treated the same. Which means “I’ve got to maximize every single dollar I have”, and if you step back a little bit and, not to get philosophical, but if you think about what’s the value of money or what purpose does money serve in your life – a lot of times it’s to give you freedom, it’s to give you some type of security, and if you start the conversation there, not every dollar in your portfolio has to be treated the same way. So, I think it’s completely appropriate to look at some dollars and say “Okay, these, this money should be treated to give me security.” or cover certain things, and so that may impact how you approach what’s available in the net lease market.
Another strategy that we’ll see that can be a little more entrepreneurial is, as I said before, a lot of these investments come out of the gate with 20 year leases. When you begin to cross the threshold where there’s 10 years remaining on the lease, and knowing most banks will give you 10 year mortgages, when you have fewer than 10 years left on the lease, that would be the time period when the value would be impaired in theory. Meaning even though that tenant could be doing your gangbusters business and could have great credit, you are introducing the lease expiration into that conversation that may have 7 years left, or 3 years left, and so that’s uncertainty. And so, whoever’s buying that property from you will want to be paid for that type of uncertainty, and the bank will want to make sure that their protected from that uncertainty. So, the loan dollars may be lower, the buyer pool may be smaller.
On the other hand, if you want to be more entrepreneurial, that’s where some buyers will look at those properties with the lease expirations, where you have fewer years left on the lease, because that may be an opportunity to pick up something at a better cap rate if you’re willing to do the market research or you’re comfortable with the risk. Either the tenant is going to renew or retenent it, or some other option. So, that’s one of the areas where the business can become more entrepreneurial.
Richard: Right, makes sense. Okay. Who is a typical triple net investor? Are these mostly institutional investors, or is it a whole bunch of retirees and the institutions stay away, or?
Peter: That’s one of the misnomers of the industry. About 75% of the industry is actually run by institutions, it’s in the billions and billions of dollars of publicly traded rates, large private equity firms. So most of the net lease market is actually controlled by institutions, it’s about 25% that’s private individual.
Richard: Okay, great. What do you think the future of the net lease commercial real estate market really looks like?
Peter: I think, just from a demographic standpoint, you know, you have the baby boomers who are continuing to run through the demographic cycle, and that bodes very well for this asset type. I think as you see the economy diversify, everything that’s happened over the past 6 months – you’ve seen what’s happened with supply chains, warehousing with Amazon, and all that type of last mile stuff – so you’re seeing whole categories of real estate change in terms of how they’re used and companies uses of them. I think that’s going to expand; the real marriage with net lease is that private investors that want to own the real estate. You have companies that want complete control over their real estate but they don’t want to own it.
If they have an operating business, they’re most likely making 20-30% margins, or hopefully they are, in their operating business they don’t want their money tied up in real estate that maybe appreciates 3% a year or whatever. So, it’s a perfect marriage between investors who want to own real estate but don’t necessarily want to operate it, and companies that want to operate their real estate but they don’t necessarily want to own it. So I see this trend continuing because it’s good for companies, and also just the demographics of the investor pool in the country as people shift from management intensive real estate to this type of real estate.
Richard: Right. It’s interesting how seldom net lease real estate investments come up compared to multi-family, self-storage, within the private investor space. So I appreciate you bringing all of that up. In terms of the future of net lease properties, on how they’re identified, valued, traded, invested in, do you see technology drastically changing this area? Or pretty much the same as all the other areas of commercial real estate, people are using technology more now in deal sourcing, in connecting with each other – is there any unique trend you’ve seen with net lease properties that’s different than other niches in a way?
Peter: Yeah, I don’t know that I would say it’s particular to net lease, but in the entire real estate industry, real estate as far as all the industries, it’s probably one of the laggards in terms of technology, but technology is bringing a lot more transparency, it’s bringing efficiency. You know it’s crazy if you compare like what Air BnB did to the hotel industry, or a lot of the travel sites for example. If you want to find out what hotels are available in Los Angeles, for example, you can do that from your desktop anywhere in the country. If you wanted to find out all the triple nets that were available in some city, or any piece of real estate for that matter, we still don’t have an aggregated technological site or company that has figured that out and there are several different reasons for that, but it’s heading in that direction. So that transparency, I think you were asking about the long term implications, and we could go into crowd funding and some other things, but as the information is more democratized, as the access and opportunities to invest in these asset classes are democratized, in theory that should bring cap rates down because you’re expanding the buyer pool. You’re making it more transparent, and you’re making it more easily accessible.
Richard: Okay, great.
Peter: That was exciting.
Richard: Yeah, for sure, and it sounds like there’s some big changes coming. What would be a way to add value and boost the valuation on a net lease or triple net property? You mentioned earlier maybe extending the lease term so it’s not impaired. So if there’s less than 10 years I would guess that would be one way; is there another way or two to add value and kind of boost NOI or boost the return for an investor?
Peter: Yeah, so the cash flows are set. That’s a lease, it’s determined, it’s predetermined, and so all the value creation here is not really going to be something that you’re going to do like another piece of real estate. Where you can offer something else to the tenant or something like that and they’ll pay more, although maybe that would occur. A lot of it has to do with the transition points in the lease and the ownership period, and it has to do with financing. So, many leases for example they have increases that occur, the rent jumps after 5 years, or every 5 years. When that occurs, there is a, obviously the rents jumping the value is going to jump. So depending on what your entry point was on that piece of real estate, what your financing is, you may have a little bit of cap rate compression, and your rent went up so there are certain periods where if they’re timed correctly, that may be transition periods where you can actually make a profit.
Sometimes we’ll see with some of the bigger properties that have a lot of land, there may be a collaboration between you and the tenant to parcel off some of the land and you can use that with another tenant and therefore the company gets a cash infusion and you can add some value. Those are not run of the mill, but there are kind of unique situations that I would put out there that you could look at. So I would categorize that in just being creative with real estate, you know, just a creative real estate professional.
As we discussed, you get toward the end of the lease term, if the tenant is doing very well, they’re not going to want to leave, they’re going to want to extend. Probably the biggest misnomer in the industry is outsiders really discount the value of having the lease with a credit tenant, and having that already done, and cash flowing, and operating, and how valuable that is. So, for example, if you had 2 years left on a lease, and they were going to extend the lease, and the rent was going to go up by 5% or 10%, add that to your point – yes, your rent may go up by 5 or 10% in a couple years, but there may be additional value for you at that moment to extend the lease by 10 or 15 years and not raise the rent as much if you had good credit. Because now a new investor can come in and buy that asset knowing they have a new 10 or 15 years left on the lease instead of 2, and there would be value creation there. So, you kind of play that by ear.
Richard: Okay. If someone wanted to compare an apartment building investment versus a net lease investment – I guess one is very active, one is more passive, in an apartment building you might be able to boost NOI by adding revenue in a few ways or do better property management and your income is going to fluctuate month to month quarter to quarter – when an investor is looking at where to allocate to, you talked about diversification earlier in this interview series, so would you say that when an investor is looking at these two types, it’s not really which one is better, it’s just they’re very different in that if you do want diversification it might be good to consider both? Or would it be a major negative trade-off of one versus the other? Maybe if an investor is looking at that option.
Peter: I think they’re completely different investments, but I think the drivers for the investors themselves are very similar because one of the benefits of investing in multi-family is you have a 100 unit property, you have 100 different rental streams. So if you have a problem with 2 or 3 them, the investment is still going to perform fine, it’s most likely going to continue to cash flow, and that’s a problem you can solve and move on. So I would say one of the number one reasons why people like multi-family is because of the risk dynamics; people need to live somewhere, it’s not going to get evaporated by Amazon and your income is diversified amongst many tenants. So you’re looking for income, and you’re looking for security of income. Those are the same things that people who invest in triple net properties are also looking for. So they marry together and it’s the same concepts, it’s just different words. Now you’re talking about the credit of the tenant, and you’re talking about how is the lease structured and what are the economics of the lease.
Richard: Sure, okay. You see hundreds of multifamily properties every quarter, I know – what are some of the most important things to look for when inspecting a multifamily property?
Peter: I think the biggest thing that comes up as far as multifamily is, you know, obvious all of the physical condition aspects. I guess you would say in that industry that these are assets where people live, so they’re living, breathing things, things have to be – they break, they have to get repaired, that’s part of the business. What you want to try to prevent is repairs that come up as big surprises, and most of the big ones are well-known and you can research ahead of time. So, and in this conversation where we’re comparing against net lease, probably the biggest risk with multifamily is your operations and your execution team, and operating multifamily is definitely a team sport. Depending on how big it is, you have third party management, you have asset management, and you have all of the vendors and the soft skills. So, there’s so many different types of players that you have to interact with from vendors to bankers to attorneys to the tenants themselves, and your residents who are actually your customers.
There’s a lot more flavors that you have to be able to handle and manage. So, things can go wrong in all those categories, and also things can go very well. That’s the two sides of the coin – the opportunity and the obstacles, right?
Richard: Sure, sure. What about out of all the properties that you have seen in multifamily and commercial real estate, what are some common mistakes in the valuation process? And that could be a mistake that could be costly to an investor, or perhaps the valuation was a little bit low, and it’s an opportunity for an investor because someone made a mistake in valuing, you know, what the property truly was worth. What are some of the mistakes you see there?
Peter: I’d say when you talk about the value add properties, the two biggest mistakes that I see most commonly made are people overestimate what they can achieve in rents after they do their value ad work. So, we’ve all seen financial models, and the fact of the matter is that if you make a small increase in your assumptions in your one or two, and you carry them out 10 years, a small increase can make a really big difference 10 years later. And if you overshot your expectations, or your assumptions, early on it can really change the nature of things. So, you want to just make sure your assumptions that you’re making in terms of a value add are backed up, that you really know what you’re what you’re talking about. If you’re talking about being able to raise the rents that you can prove, generally through some type of comp, or at the property themselves, that you’re actually able to achieve that rent.
The other is typically you underestimate the cost that it takes to get the units or the property up to that level. So, it’s budgeting and assumptions.
Richard: Sure, that’s great. Yeah, I know a lot of people, they always have these amazing predictions and graphs of how things are going to go, right? It’s never a prediction that it’s going to be bumpy in my experience. What’s the number one way to drive revenue up on an apartment building investment?
Peter: I would say, right now, obviously this varies significantly depending what class of property you are and what renter you’re trying to attract. So, first of all, knowing, really knowing who your customer is. There are certain customers now that if you’re making your units tech enabled and putting in Nests or all types of virtual concierge and stuff like that, the tenants are looking at those types of amenities and they’re appreciating them and they’ll pay up for them.
Other ones, it’s very simple upgrades to the unit that are less costly, but that will separate yourself from the competition. That could be stuff for flooring, molding, a lot of the typical upgrades. In general, the more care you have in industry, and the more thoughtful you are with how you’re creating an environment for your tenants – you know, this is peoples’ home.
If you think about what we’ve all experienced this year, it’s their home, it’s their school, it’s their gym, it’s their restaurant, it’s their movie theater, it’s all these other things. That’s probably the biggest thing that’s coming through all property types in all locations is that the reputation that the ownership has with their tenants, in terms of are they really going out of their way to try to make it the best living experience? That’s coming through in collections, renewals, tenant relations, and property performance.
So, there’s not one answer to that category because it’s a soft skill, but we’re really seeing those who do that aspect of the business, those who do that well, they’re reaping the benefits of it right now.
Richard: Right, great. Yeah, that makes sense. It makes sense it would be especially emphasized during a pandemic when…
Richard: When people, even if you’re only somewhat locked at home, you just can’t go out to eat as much, you can’t go to the movies as much, like you said. So even if you’re one that’s a little bit more bold and not really – you hate masks and you want to go out and live your normal life, your normal life is still less normal, you know, in these times at least. So, that’s great. Just two more quick questions – what was key in your past in doing $1 billion plus a year in commercial real estate brokerage transactions year after year? What was key in that in case there’s a broker listening or someone who’s just getting into brokerage right now?
Peter: I would say in a word it would be just being a good listener. Because it’s in the listening, and implicit if you’re a good listener you’re less transactional. So people can really feel if all you’re trying to do is to make money as quickly as you can with someone, but if you play the long game and take a long-term approach it may be a little slower in the beginning, but if you have your value, you know your stuff, that will definitely pay off over the long term, and that builds. As you incorporate technology into your process, and incorporate teamwork, and you’re thoughtful about your teamwork, which all clients expect right now – the technology, the teamwork, the combination and being long-term focused – if you do that well, and then make sure that your specific knowledge that you are being sought after for, if you have that all as a winning combination, and they’re all improving each year, you’ll do very well.
Richard: Great, yeah. Appreciate you bringing that up. My last question here is how could someone first get started as a commercial real estate broker? Like, what’s the first step or two they should take so they have a good foundation in the industry?
Peter: Without a doubt, if you’re new you want to associate with someone who’s not new. That can look at different forms, and a lot of the time whatever market you’re in you may have 2 or 3 choices in terms of your entry point you have to pick the best one and it may be someone who’s got 5 years more experience than you and it’s a very small partnership. Or, it may be like in our situation where there’s a team and an organization that has almost 20 years of experience and there’s a whole structure that can give you a very diversified support system and also a knowledge base to tap into.
I can’t think of the phrase right now, but there’s like hundreds of these of how much time you save and how much more money you make – you don’t have to reinvent the wheel the first time. It’s probably the most common mistake; someone who’s getting into the real estate brokering industry, they’re driven, they want to do it themselves, and those instincts are very, very good. But you want to put the teamwork in there because a good team member can save you years, and years, and years, and help you to leap frog. So, that would be my biggest advice, it’s to really research and at first research a good person to associate with. At first, it’s not about the money. When you are entering, it’s not about the money, it’s about what you’re learning.
Richard: Right, right. So the more long-term medium focused on learning and being mentored by someone who is a true veteran expert, not “Oh, where do I get a 64% versus 79% split…” just, you know, flipping that mindset.
Peter: 100%. I mean it was very common for me to see the first 10 or 15 years I have several stories I could mention of people I would watch enter the industry and they would, kind of by luck, do 1 big deal and then they would go through 2 or 3 years and not to any deals and then maybe do 1 big deal. You would say “Okay, well in that 3 year period, maybe average out they did pretty well.” but if you come back to them 7 years later, compared to someone who during that same time did 40 or 50 deals, now they have hundreds of clients and not to mention all of the additional client relationships they’ve made during those times. Their income, their contact base, their knowledge base, it’s much more diversified, it’s much more robust. So, you know, just like anything, it’s really about playing the long game and not trying to short-cut.
Richard: Right, yeah, that seems important in every part of business, or investing.
Richard: I appreciate your time here today, Peter, and thanks for a CRE Power Player on CommercialRealEstae.com. I appreciate all the advice and insight, and taking your time out of the day to do this interview here.
Peter: Absolutely, Richard. Thanks a lot, it was a lot of fun.
Richard: Yep, thank you.