CORONA DEL MAR, CA—Outside of dollar stores in tertiary markets, 6% and 7% cap rates do not exist in California’s current retail cap-rate climate, so investors are eyeing multi-tenant pads in strong markets outside of California, Hanley Investment Group associate Jeff Lefko tells GlobeSt.com. As we recently reported, Lefko, along with the firm’s EVP Bill Asher, completed the sale of two new construction multi-tenant pad buildings in separate transactions in the Kansas City metro area. We spoke with Lefko about why California buyers are attracted to multi-tenant retail investments in other markets and where he sees this trend heading.
GlobeSt.com: Why are buyers from California still looking for multi-tenant retail-pad investments in other parts of the country? Lefko: Outside of dollar stores in tertiary markets, 6% and 7% cap rates do not exist in this current cap-rate climate in California, so the next best option for many passive investors is multi-tenant pads in strong markets outside of California. With multi-tenant pads, investors get the return they desire and a predominately passive investment. Many investors also choose multi-tenant pads over single-tenant properties to diversify the risk if a tenant were to leave.
GlobeSt.com: Which are the hot regions for this type of investment from California-based buyers?
Lefko: Cities that are established with strong demographics have a track record of commanding the lowest cap rate on multi-tenant pads. Typically, the investors are looking for at least 100,000 people in a 5-mile radius and average household incomes at or above $70,000. Areas that are five or 10 years ahead of the population growth have a harder time achieving the most aggressive cap rates unless the sellers can prove a track record of strong tenant sales. Also, investors want to be able to access the property with a direct flight from their nearest airport. Properties that are close to major airport hubs have a larger buyer audience than the ones that do not. GlobeSt.com: Do you see this as a long-term trend, and if so, how long? Lefko: Multi-tenant pads are an extension of the single-tenant properties, which has always been a product that trades with a lot of velocity due to the low price point and ease of management that are attractive to a large buyer pool. The main driver of this flight to quality is a lack of similar properties at the desired cap rates in California. As long as this remains true, the trend of California buyers looking for multi-tenant pad investments in other parts of the country will continue in the future.
GlobeSt.com: What advice do you have for sellers developing multi-tenant pads?
Lefko: When negotiating leases with tenants, sellers should be cognitive of expense caps and how they may impact the seller’s exit value. Make sure to keep uncontrollable expenses such as snow removal and utilities uncapped. In states where taxes reassess upon sale, negotiate any kind of tax protection out of the lease. Small amounts of slippage can have a large impact on a capitalized value. Additionally, we are in a time period that as soon as the building is presentable, prospective sellers should put it on the market even if the tenants are not open. Focus on getting the property to the market sooner than later. Buyers can get comfortable with a rent credit for a tenant that is not yet open. GlobeSt.com: What advice do you have for buyers developing multi-tenant pads?
Lefko: Investors should focus on the real estate fundamentals in regards to strength of tenancy, ease of access and visibility. Buyers must have a more heightened sense of these fundamentals because there is more room for error, especially in a foreign market. The world has become a lot flatter with the use of Google Maps and all of the tools available to look at an area virtually, but it should never be a substitute for visiting the property in person. In regards to pads that are a part of a larger shopping center, investors should make sure that they fully understand how the CC&Rs govern the shopping center and if there are annual expenses associated with the CC&R agreement. Also, look for any type of termination rights that would allow a tenant to get out of its lease. GlobeSt.com: What else should our readers know about this trend?
Lefko: Buyers of new-construction multi-tenant pads are looking for properties leased to food and service-oriented tenants. The name of the game is Internet-resistant tenants that are here for the long haul. Also, pads with a drive-thru on the endcap help attract high-quality coffee and restaurant users and push the cap rate lower.