Investing in Flex Space (& Running the Numbers!) with Hamza Ali
Flex industrial is a wonderful side of commercial real estate to invest in - especially for beginners since the asset is typically easier to manage with low-maintenance tenants. Today, we're diving into everything you need to know about flex space for beginners with Hamza Ali, who is a seasoned commercial and residential real estate investor with an investment portfolio of over $270M in flex space developments in Texas.
Get commercial real estate coaching, courses, and community to jumpstart your investment journey over at CRE Launch Pro: www.crelaunchpro.com
Key Takeaways:
Flex spaces have very low vacancy rates and high demand that cannot be met by new construction.
Flex spaces can accommodate a wide variety of business types as tenants, from gyms to offices to manufacturers.
Land for flex space development should be under $5 per square foot to make the numbers work.
Construction costs for flex spaces are typically $85-125 per square foot.
Target an 8-9% cap rate upon completion and stabilization, and expect to sell at a 7% cap rate for profits.
Flex spaces are one of the easiest types of commercial real estate to invest in for beginners.
About Your Host:
Tyler Cauble, Founder & President of The Cauble Group, is a commercial real estate broker and investor based in East Nashville. He’s the best selling author of Open for Business: The Insider’s Guide to Leasing Commercial Real Estate and has focused his career on serving commercial real estate investors as a board member for the Real Estate Investors of Nashville.
Episode Transcript:
0:00
All right, I'm caffeinated and excited because today we're gonna be diving into what I think is the easiest commercial real estate asset for anyone to own. Whether you are a beginner or you're an advanced investor flexspaces, basically the equivalent of five plexes in multifamily, but Hamza tell us what flexspaces Because I know that there's some confusion out there as to what it is. And sometimes there's, I would say, an easy entry for any beginner think about a single story single family home, I would compare the flex space equivalent to that, in the, in the world of commercial real estate, what flex space allows you to do is it basically allows you to build these small metal buildings, and you can have multiple tenants within one building, there is a huge demand right now. And it just can't keep up, I'm going to do something that I haven't seen anyone else do on YouTube. And we're going to actually dive into every single aspect of the deal and break down the numbers from land acquisition to rental rates, so that you can go out there and confidently build or buy one of these assets yourself. What kind of tenant base do you typically find in flex space, most people I think get intimidated and think these are industrial manufacturing guys who are coming in and doing heavy lifting, and it's really not the case. Pickleball is probably now the number one most desired tenant to have in a flex space because all they're really looking for is empty space last year or the year before. Rather, it was podcast studios, we've seen daycares. We've seen boxing gyms, CrossFit gyms, you know, we have swimming pool companies, law, more repair facilities, anything that might need a little bit of warehouse or wide open space, in addition to their offices, and may or may not have loading docks, but probably do have larger roll up doors so that businesses can move product in and out depending on their needs. And you probably guessed that it is very creatively named because of how flexible the uses are, within this asset. Talk to us about the vacancy and demand rates for this type of product. I like to see them being built in high growth corridors in brand new neighborhoods where land is abundant, and still relatively inexpensive so that the numbers work. And the deal makes sense right? Now one thing that you may or may not know is that flex space is actually one of the most in demand commercial real estate products out there. Aside from affordable housing, vacancy rates and flex space are unbelievably low. In fact, they're probably at historic lows today. And that's because we cannot build flex space fast enough to accommodate the tenants that are taking them. How do you make the numbers work on a flex space do like when you say, you know, we're looking for cheaper land, what does that mean to you, to make it very simple criteria is extremely simple, right land needs to be below $5 a square foot, you need to have at least an acre for the numbers to work. So one acre below five bucks a foot. And then you need to build at least 10,000 square feet. Anything more than that is I would say just added value that you are going to benefit off of. But let's get into the numbers of this deal. I'm going to break it down from a build and development perspective, if you want to skip ahead to buying these assets in as is condition, check out the timestamp at the bottom of the screen. But I will say there is far more money to be made on the construction side if you're going to go develop these yourselves. And it's really not as difficult as most people think it is. So if you're looking at developing your own assets in the flex warehouse world, the first place you're going to look is for land that is actually affordable to where you can build this asset and make it profitable. So we know that our land is going to cost about $5 per square foot. But what about construction costs? Well, just like every other property type in real estate, construction costs have gone way up on flex space. But the good thing is, it's still cheaper than most other types of commercial real estate out there. Because you're not having to finish it quite to the level that you would say a hotel or an apartment complex, you can expect to spend anywhere from 85 to $125 per square foot on the site development and building costs. So your horizontal, which is the ground and your vertical, which is your structure. So if we take our $5 per square foot for the land, and we attribute 100% of that to the 10,000 square foot building, plus our build costs, that gives us $136 per square foot for our build costs. $136 is just an example. You could do it way cheaper, it could also be far more expensive. But in my experience $136 a square foot is fairly conservative. So chances are pretty good that you'll be able to come in under that build cost, sort of break that down a little bit further. For those of you that may not know how to run numbers on dollars per square foot per acre $5 per square foot per acre is about $240,000 an acre. There's 43,560 square feet in an acre. So just multiply the two and that will give you the number finding land at that price is not really going to be feasible within the urban core of any market but that's the beauty of flex space. You don't have to be immediately downtown in order to make
5:00
Make these deals work. A lot of these companies just want to be located on high traffic corridors near interstates so that they're easily accessible. And the benefits of that is they don't have to deal with traffic when going to work. So if $240,000 An acre for a 10,000, square foot building works, but you might be able to build more, imagine how much better those numbers will look if you can build 15 or 20,000 square feet. So let's say that you're able to build 20,000 square feet, but don't necessarily have the cash to do it today, or you don't want to raise that capital from investors. Just plan it in two phases, build the first 10,000 square foot building, lease it up, pull all of the cash out through a refinance and build your second building. This is a typical 2x return or 2x multiple exit for you, right, so if you put $100,000 in, you're gonna get $100,000 out. So it's very easy to run numbers on an existing asset and what your potential exit will be. But what kind of cap rate should you assume when you're building commercial properties? Well, it really comes down to the yield that you need to get on your property. Typically, what I recommend is an 8% to 9% cap rate upon completion and fully leased up, that gives you enough spread to cashflow if you need to keep it but you'll probably be able to sell it for a 7% cap rate, which means you're going to capture the Delta there in your profits. So let's break that down a little bit. If you're building a 10,000 square foot building at an all in cost of $136 a square foot, you're going to be at $1.36 million total cost. Now if I'm going to rent it at an 8% cap rate, I'm going to be renting it at about $108,800 per year on a triple net basis. Now if I sell that income at a 7% cap rate, so just dividing 108,000 by 7%, that's going to give me an exit price of $1,554,000. So the delta between those two is just under $200,000. Not including any real estate commissions or fees or closing costs if you're going to have to pay that. So let's break down what the returns would look like. In this case. Now my underwriting is a little bit more conservative than Holmes's bet, let's assume you put 25% down on the 1.3 6 million, which is $340,000. And you've profited $194,000, which gives you a 57% return in probably about two years at over 25% a year. That is almost twice the value that you can get out of the stock market and anything better than you could get in multifamily today, considering how high interest rates are and how low the cap rates are on multifamily. Now if you're wondering how we got to the 108,800, yes, it was an 8% cap rate. But you're going to assume about 16 to $18. A square foot triple net on the leasing rates, depending on your market may be a little bit less could be a little bit higher if you're in an area like Nashville. But that's a pretty good estimate for you to use. When you're putting together your initial underwriting when I was starting off, obviously, there's two schools of thought one of them is cashflow, and the other one is a refi. So you refi out you get a little bit a little bit of equity. And I actually created a whole new school of thought which is sell the whole thing entirely just because the demand, like I said is so high if you think about it, right, every deal that you sell, and let's say you're making a two extra term minimum, right, every deal that you sell allows you now to do two deals. And if you follow that path, if you follow that journey, eight years down the line on a refi scenario you would do, let's say three referrals over 10 years or eight years, whatever it is, versus every deal gives you two deals, you end up with like eight deals at the end of eight years versus just three. So once you're looking to sell this asset 7% cap rates are a pretty realistic exit considering today's interest rate environment and market conditions. Now depending on where you are located, it could be a little bit lower, it could be a little bit higher. But when I'm running my underwriting, I like to assume that we're going to be in the middle of the road, right. So 7% is probably what you should underwrite and expect to hit as you're exiting these assets. Now, if you're buying these assets, you'll want to make sure that there is some room for value add, right because you can't really afford to pay a 7% cap rate with interest rates at seven to 8% and expect to make any spread unless you're planning on paying all cash. Now that value add could be from building up new tenants raising rental rates and more of your operational side of things. Or it could be adding another building to the property and leasing that up as well. The good thing is that a lot of your due diligence on Flex warehousing should be fairly simple if the product is newer, because a lot of landlords are going to a triple net style lease meaning the tenants are responsible for their share of the commentary maintenance, the property taxes and the building insurance. So if you're coming from multifamily into flex warehousing, you don't have to worry about your insurance rates going up like they have over the past year. You don't have to worry if the property taxes go up those
10:00
costs get passed directly through to the tenants. So your base rent is what you are going to collect and what you can count on for the next three to five to 10 years depending on how long your lease is. What do people often get wrong about flex space as an investor what people often get wrong is they get intimidated by the fact that it is commercial real estate and they think it must be difficult to get into. So I'm gonna go ahead and buy four more houses and deal with four more tenants and four more roofs and four more H Vax and I think that is where they get everything wrong, which is why I took it upon myself you know, to start social media, get on YouTube, get on Tik Tok, get on Instagram and talk about all of these things and show people that look, these are my tenants, I actually go and have a conversation with them. And this is the business that they do it with. And believe it or not, I think I've changed quite a few minds, as have you. And I think we'll continue to do that man as we as we progress. Now, having gone into all of that with Hamza today. I think the flex space is by far the easiest commercial real estate investment to own. Let me know what you think in the comments below. And if you want to learn more about development, so you can do these projects on your own, check out this video here.
In this episode of the Investors Round Table, we'll dive into the crucial process of finding and analyzing profitable commercial real estate deals. Logan, Matt, and I will share our insights into identifying market opportunities, evaluating risks, and building a steady pipeline of deals that deliver strong returns.