Josh Barker Real Estate Podcast #21

Josh: All right. Thank you, everybody, for joining us today, it's the middle of August, and I'm sitting here with Chris Haedrich with Haedrich and Company, it's a real estate commercial brokerage here in Shasta County. And first of all, Chris, thanks for coming.

Chris: Thank you, thanks for having me.

Josh: Absolutely. For our listeners, one of the reasons why I wanted to bring Chris in today is that Chris is an absolute wealth of knowledge here in Shasta County when it comes to commercial real estate. In fact, Chris has not only helped me and represented me multiple times, but you're selling something for me right now.

Chris: I am.

Josh: People might find that to be odd real estate brokers having another real estate broker taking care of some transactions for you, but I believe in hiring the best people for the job. And many times when you've helped me in the past, I felt that you were the best person for the job, so thank you.

Chris: I appreciate that. And vice versa, we always send PB your direction for the residential side, and we appreciate what you do for them.

Josh: You bet. Well, thank you, thanks a lot. Diving right in. No reason to waste any time on this. Let's get into some of the numbers right now. Some of the questions we get are, "How is the commercial real estate market?" Do you want to share that? Would you like to respond?

Chris: Yes, we typically, I feel like, are always having this constant battle, so to speak, with the national rhetoric and what you're seeing in the national media of, "Oh my gosh, commercial real estate is doing so terrible." And it really is. There is the whole... The pandemic certainly didn't help. The work from home, the lack of wanting to come back because of the conveniences of working from home, the lack of needing to do any type of commute. So as a result, a substantial amount of office space is available, vacant in these larger cities like Sacramento, San Francisco, San Diego, Chicago, New York, and wherever. And for that reason, there's some fear and some concern.

Josh: Does that really apply here in Shasta County, in your opinion?

Chris: It doesn't. And that's why I feel like we're always having that battle, having that discussion, because many people are asking, "What is going on here in Shasta County?" We're always worse than the nation, and it always takes us longer than the nation to get better. And that happens. That's not incorrect. But I look at it as when the great recession occurred. We did do the same thing before it. Like everybody else, we drank the Kool-Aid that was, "Oh my gosh, real estate's everything. Let's overbuild." And everybody became a developer, and there was a ton of vacant space. Great recession hit, and we had an abundance of inventory in all industrial, office, medical, and retail sectors. And as a result, rental rates come tumbling down as they tried to fight for the few tenants that were even confident enough to move their space or lease additional space. And values came down, people started losing buildings and properties and were hemorrhaging money while trying to pay for the overhead of vacant space. And so we had a huge inventory problem. And the benefit of our market being so slow to respond and get back is that we've been taking all of this time to get through our inventory. And so, there has been little development and new construction for a long time.

Josh: Yeah. And so responding to that, so big picture, what I hear you saying is that nationally, a lot of these commercial office spaces are vacant, and that's because of the work-from-home situations, people are changing the way in which they operate and run their businesses, and so you have vacancy factors in these major cities, and in some cases, they may have overbuilt too. But here in Shasta County right now, there are only a few vacancies, which we'll talk about in a minute, improved vacancies, like improved office space. But right now, in here, in our town, a lot of people go to work, and so there's not a whole lot of telecommuting going on here, and so for those reasons, there's demand. Right?

Chris: Definitely. And even though work-from-home movement here, which did occur to some degree. It might be work from Redding from some of the people that even moved up here, but a lot of times, the commute here is 15 minutes, I always joke that you can get anywhere in Redding in 15 minutes.

Chris: And so if you can get somewhere in 15 minutes, then it's not so lucrative to say like, "Okay, I'm gonna have an office in my house," because then you got your kids, you got different things, and you just have... So there are quite a few people who, despite moving to Redding, needing to work from home, or not needing an office, still say, "I'm gonna go get a space downtown." Our downtown in Redding right now is really going strong. Very, very hot market, especially for independent, just one-party offices, little CPAs or massage therapists or... You name it.

Josh: Yeah. What does our vacancy look like downtown right now?

Chris: Here's the thing, when I said that there hadn't been a lot of new construction, it's true. The only new construction that has really occurred is on the retail side, where you see Costco, and across from Costco's project, you have the Churn Creek marketplace, 175,000 square feet of retail space there. And then also Costco is obviously going through their construction right now for their pad sites that are out there. Downtown, same thing, mostly retail. The retail that you see along I-5 is mostly underwritten with national tenants, so it makes financial sense for them to do that with the national tenants. The downtown stuff is underwritten with grants, so there's quasi-government funding there. And certainly, with the county courthouse, a $170-odd million project will hopefully be completed here shortly. So there are those projects.

Chris: But otherwise, the general private sector construction is what I'm talking about. It really has yet to occur. But if I tell you that in downtown, we're at historically low vacancy, historically low vacancy. And we look at it at... Really, we're in the 6% to 8% range, which historically we're well above 15% just for a number of reasons that we can go into if you'd like. But because of retail... Any property's highest and best use is retail because it has high exposure. And so that means you're typically driving right by it. And so if you're driving right by retail and you see something that's vacant or has a for-lease sign, then we get calls all the time going, "Hey, there are all kinds of property vacant. It's vacant everywhere." Well, you're seeing what's in front. What's happening in the back, the second floor, or all those other properties... So office-wise, we need more office supply downtown.

Josh: Interesting.

Chris: And our retail is starting to be absorbed in a great way, some of which we've gone public with, some of which we're about to go public with, so.

Josh: Yeah. Now, are you talking about the development with the apartment buildings up above?

Chris: Yes, so there is Market Center, which was there at 1551 Market Street, with Apricot Lane in one corner, so there's the public market, the Redding public market that's going to go in there. And there are 13 different spaces; of those 13, we have 11 done.

Josh: Eleven done?

Chris: Yeah.

Josh: No way.

Chris: Yeah.

Josh: That's incredible. So this is going to be filling up really soon.

Chris: It is, yeah. We're in the process of doing all the designing right now. In fact, I was down in the bay area visiting a couple of different markets with a couple of architects this last weekend just trying to fine-tune really little things like, Where should this be? What does the flow look like here? Where is the bottleneck and all that? Which is fascinating to see. But really exciting what that's going to bring to downtown.

Josh: Absolutely.

Chris: And then with that, there's a lot more reason why different offices again are going to... Businesses are going to move down there, but we've had a number of large businesses specifically move down to downtown because they wanted to be in that more urban setting, where they could walk to get coffee, and they could ride a scooter somewhere and have some more of that feel.

Josh: Yep, well, remember us on the east side of town too. I'm off of Hilltop Drive, which used to be obviously more of the commercial side of things, the retail side. What's going on in downtown, of course, is really amazing. When you look at a broader perspective, let's use a couple of different classes. For example, is there a lot of general office space available for purchase right now?

Chris: No. Not in my opinion. So on average, just the quantity of space available. We're looking at a little over 200,000 square feet, which sounds like a lot, but it's around 7% vacancy to us. And really, because of the lack of construction over the last decade, you're getting through most of the higher-end stuff. But it provides so much opportunity, so now we're seeing more of... Where you are, on your end, with residential, there's a lot of opportunity for people to step in and do house flips.

Josh: Sure.

Chris: We typically had that less often. Very rarely did you ever build a spec building? That occurred back before the great recession but never since. Now people have the confidence to pick up buildings essentially for a flip, not always intending just to turn around and sell them, but just make them look nicer.

Josh: There's some upside to it.

Chris: Yeah, it actually makes financial sense to do that. And there's a number of parties that have been doing that downtown and doing it successfully. And once a couple of people do it, it starts to get exciting.

Josh: Sure. Let's say I'm owner-occupied, a doctor in town, I want to have a medical office space for myself, or I'm a chiropractor or a real estate broker. None of them are expanding right now, by the way.

Chris: Yeah.

Josh: But generally speaking, if you look at people that want general office space, could they buy a building right now that's not downtown, that would be just in general around the county.

Chris: There are a couple of properties that we'll joke about in our office, saying, "Man, if I had three more of those, I could sell them. And it's not always you say that just anecdotally as you're standing around the water cooler, so to speak, but that's the environment that there is right now. Obviously, there's an assumption that the price is fair market and it's appropriately priced.

Josh: Of course, yeah.

Chris: But if there's a good-quality property that comes on the market, a standalone building, and I would say 5000 square feet or less, it should sell fairly quickly. Fairly quickly, in our industry, is typically somewhere in like a hundred days or less. So the residential world, I'm curious to know what your days on the market are on average. What is it?

Josh: Right now, we're seeing 85 for the market from when you list it to the day it closes escrow.

Chris: Oh, to the... It closes escrow?

Josh: Yeah.

Chris: Yeah. See, our average in commercials is like 260 or something, and I have it in your...

Josh: Yeah, we're just better than you on this side.

Chris: I don't doubt it, actually. I've seen your processes. I'm impressed with what you guys do.

Josh: No, I'm joking, I think... Because that's the MLS number, that's not my number. It's the MLS number. We're much faster than that.

Josh: But the 85 days on the market are obviously the volume, so there are 230 to 240 units selling in a month here in residential. Well, there are few units selling in the commercial space. But let's say I'm one of those folks that do wanna buy that building right now. What would be an average 2005, or 2006 building, 5000 square feet, good location, good parking, no weird stuff, and a standalone building? Is there a general idea of the price per square foot on something like that?

Chris: Great question. I avoid the price per square foot because we get so into... And we're really based on the income potential.

Josh: Totally.

Chris: And you're going to be somewhere between 150 and 165 bucks a square foot for something in that range.

Josh: Okay, something in that range. Okay. Good, that's fair.

Chris: And then if you go medical... So that's a professional office. If you go medical, you're going to go another 100 bucks a square foot for the most part.

Josh: Right, right, because of the improvements and stuff like that.

Chris: Yeah, right.

Josh: Okay, so let's talk about financing on that for just a minute. Do you have just a general idea... Let's say I'm going to put a total of 20% down on a building, whether it is with SBA for a portion of it or not, but 20% down, owner-occupied building. Is that even a loan that's available to them?

Chris: It is.

Josh: Okay. And is there a general idea... Rates change to guys all the time, so this is almost a worthless question, but generally speaking, where would the rates be today? Six and a half, 7?

Chris: Yeah, exactly, for the most part, yeah. If you're going to do SBA financing, and you're going to jump through those hoops, which is worth it, it is a headache for sure. But if you're an owner-occupant or you're occupying more than 51% of an existing building, and you can do the SBA financing, then you can go as little as 10% down. And if you have control over your vacancy because you are the tenant, then there are reasons why doing that might be worthwhile. Otherwise, I'm a pretty conservative person, and I typically say go with the more traditional, which in commercial is 30% down, 70% loan. And in those ranges, we're basically seeing about 6 and a half to 7%.

Josh: Okay.

Chris: And we have the benefit of some fantastic community banks here, and so there are some... Depending upon relationships and just different things that your business is doing, they will work hard to get you the best overall program for your transaction.

Josh: Sure, yeah, they want to help you out as much as they can, like keep you around. Let's shift over to more of an industrial type of use. I'm thinking of the metal building, where contractors use some of it in the back or a supplier type of thing in the back and then a small improved office space in the front for running their services. You have an idea what those types of buildings might be? Are they available, number one? Are they even out there? I don't see too many.

Chris: Those are my favorites. That is a class that we talked about. It does fall under industrial. We call it "flex industrial." essentially, it's that one-third or one-fourth office right in the front and then two-thirds or three-fourths warehouse in the back. And you see it like out there on Crossroads and Tandragee and along Prestige, and they're working on a project now off of Airport Road and Rancho. But just having been doing this now prerecession through recession and today, there never seemed to be a huge amount of vacancy or concern. In fact, it's funny when you work with some of those owners because they can be so unreasonable, and you're just like, "Oh God, you just never really knew what happened. Did you?" It's just good.

Chris: That's why that product type makes so much sense, and I highly recommend it personally as an investment style because of the highest and best use. It could be a real estate office. It could be a contractor and everything in between. Redding Countertops is out there selling countertops. So you can always find a tenant. It'd be very difficult to find one if you wanted to buy one, almost impossible. There are only a few, very few, available for lease. Historically, after the recession, rents for those types of buildings were anywhere between like 35 and 45 cents a square foot. As I said, they were always first to lease. Now, they're really 80 to a buck a square foot, and so they've seen the biggest growth.

Josh: Right. So it's not a spec because you can't build that. Inspect it right now.

Chris: No, it is difficult, but as you approach a dollar a square foot, you're getting to rental rates that are going to start to support new construction. And that may be why the project out there at Airport and Rancho stopped. I don't know. I know that developer also passed away.

Josh: Okay, yeah, changes things. Let's talk about debt for just a minute while you're getting a drink of water there. I'm going to do the same. But when you think about it... I've been watching a little bit because the Federal Reserve came out, and they did some stress testing on commercial paper and said, "Hey, a lot of this debt is being held by regional or local banks." But they felt that after doing the stress test on it, whatever that means, that even if they were to take catastrophic losses on it because it doesn't represent such a huge portion of the portfolio overall, these banks would still be solvent. I was like, "Well, that's good 'cause I don't wanna be in 2008 again." Right?

Chris: Yeah, right.

Josh: But the other side of this is that I know from just talking with many folks that there are notes on commercial properties that are coming due, and their current rates are competitive. 3, 4%. And now, in today's rate environment, they're on a refinance looking at 6-and-a-half percent to 7-and-a-half percent, at least if it's owner-occupied. It could be as high as 9% if it's non-owner occupied.

Chris: Yeah, if you're doing 9, definitely go shop.

Josh: Go shop. Good news. Good news.

Chris: Yeah.

Josh: So my question for you is this. Let's say you are a person. Let me just put you on the spot on this one. So let's say you own a building right now, your note's coming due in the next 12 months, and you are thinking, "Okay, I need to refinance this. Should I wait and see if the rates get better, or should I do it now? That'll be one question to that. And the other question is, Do I have to come in with money to do the refinance? Because there are still some ratios that I have to deal with. Right?

Chris: Yeah.

Josh: So can you help our listeners understand how that decision process might be for somebody?

Chris: Yeah, that's a good question, and I'll do my best over a podcast without visually... You probably put this somewhere visually as well. But anyway, there's a reason not to get too concerned or lose too much sleep. I tend to be optimistic anyway, but if you are getting to the end of it... A traditional commercial loan is amortized over 25 years and typically due in five. Sometimes it'll be pushed out to 10. But that means that you pay like you're paying over 25 years, and then in the fifth year, you are forced to refinance whatever you have left. It's the bank's opportunity to make sure that they don't undersell their own money by having too low an interest rate, and they have an opportunity to refinance.

Josh: Yep.

Chris: And then also the amortization, as you know, all the amortization on the front end is predominantly interest in the payments you're making. And so before you really pay down a bunch of principal, you're suddenly forced to refinance. You have to start all over.

Josh: Right.

Chris: So, on the commercial side, you have yet to have an opportunity to pay off your building. Unlike residential, if you're making the minimum payments, you have to be more aggressive. But today, because those interest rates for some people could have gone up significantly, not doubled, but gone up three basis points, that's a significant change in the overall cost of ownership of the property. Hopefully, in that case, let's say it's like an 80% increase if they're at... They weren't at three and a half, they were probably at four, four and a quarter, and now we're at, whatever, six and a half, seven. Let's say, whatever, 60% increase, then one thing I look at is, What have the rents done at the same time? And depending upon the sector, there's been a significant increase in rents overall, as I just mentioned, in the flex industrial. So there is a reason why the actual fair market rent is there to cover the overall cost of the increase. And yes, you are the tenant, so your business is having to look at that cost, but overall, it shouldn't... When the bank actually goes and says, "Okay, we have to get a refinance. We have to refinance your loan." We have to go out and get an appraisal. When they get the appraisal, the bank then determines, Okay, do we need more cash?

Josh: Right. And when you're looking at it that way, it's like, "Okay... " And the appraisal's designed if you're owner-occupying the building to help figure out what is fair market rent for the building because you might be charging yourself more than you should or less than you should, and either way, you're biased. So get the third party in there to give an idea for the bank's benefit of, Okay, what is fair market rent for this building that my customer currently is using? And that's to say that the scheduled income on a building is $5000 a month of rent. Now there's a ratio that the bank's looking at. They want to make sure that your debt service is about 1.3%... Or, I'm sorry, 1.3 less than what the... 30% less is what we're trying to say. About 30% less for the debt service than the income that you're bringing in. Right?

Chris: So, debt coverage ratio. Right? So the net income your property brings in, can it cover the debt plus a little bit more?

Josh: Right.

Chris: And so they look at wanting to make sure that it has that ability.

Josh: Right, and that might be what triggers bringing in cash to do your refinance?

Chris: It could, it could be, certainly. Most people will likely find that they're in an okay cash position as far as equity.

Josh: And that's because you think on the appraisal, with the income approach or scheduled income approach, you think that it's going to justify a high enough income?

Chris: I do because if they're refinancing right now, chances are it's a five-year. It could be a 10, but usually, it was due in five. And so they're probably doing it now, and five years ago, there's a good chance that their rent has increased to a point where there's enough equity that it will be a good cushion for the increase in interest rate, for their debt coverage ratio, which I know are getting somewhat complex. But I think the real difficulty is going to be just for the owner-occupant to say, "Okay, well, I'm used to paying $5000 a month for my own rent for my business, and now I need to pay 6000 because I need to have that additional just so that the bank feels good and the interest rate has actually gone up. So the interest rate has gone up, so now I actually have to pay that legitimately.

Josh: You have to pay more, which means you might have to move your rent up too.

Chris: And I don't know that it'll be much help, but most commercial loans have a set increase in there at that fifth year, so yes, does it force a refinance? Usually. But technically, is there an interest rate identified in the actual loan in the note? Normally. Not always, but normally. So you should double-check, make sure, because it might... And I say, "Oh yeah, in five years, we're gonna jump to 6% interest because that's gonna be crazy." And now we're at six and a half to 7, so that 6% of the interest rate in your loan actually in your note makes sense.

Josh: Yeah, that's a good point. Do you see any major foreclosures at all in the future here in commercial real estate in Shasta County?

Chris: I don't. I don't.

Josh: I haven't either. I get asked that on the residential side quite a bit too. And we track that. We use a couple of different sources to track it. We know there are some foreclosures out there. The last number I checked on it was in the 180s between... Anybody that had a notice of default all the way through, it's bank owned. There were like 180 that were showing up on the report for all of the county. And I'm like, "Those are numbers that were very similar to what they were in 2015, 2016, '17, '18, so it has mostly stayed the same in that regard, and. I think It's important we just bring this up because I'm hearing this a little bit about the commercial side, but I'm not seeing it, and it sounds like you're not either. But we know why they're saying it, it's 'cause you look at the national market like we started off this whole podcast with, and we're like, "The national market looks bad." But it doesn't look... That same fact pattern doesn't apply to the same degree here. Is that fair to say?

Chris: It is definitely fair to say. Just because they're... If you're concerned about your building, consider holding onto it and leasing it out. Move the office into a smaller space or wherever, if it makes sense. But just because there is so little inventory for lease and there are so many good-quality tenants out there looking for space. Right now, the overall vacancy isn't changing a lot because we're playing a lot of leapfrogs. As soon as someone takes one space and someone backfills their other space, and then someone backfills that space, and it's just like, "Oh, I know someone for that spot." And so much of what is happening in the commercial world is off-market.

Josh: Yeah, that almost sounds like the realtor world, too. It really does. Because that's a healthy market, is when you have a seller that's moving into another property, which is part of the challenge right now, that's why the volumes in our market have slowed down so much because the seller's going, "I'm not giving up a three and a half percent interest rate for today's rates." You can't really blame them, and there's only a little inventory to choose from. So it's like, "How are you going to get me off my perch? I like my house enough, and the rate's good enough, I don't wanna do anything." But on the commercial side, I see a lot more excitement for the future, and these entrepreneurs out there really want to make a mark in the world for themselves. And commercial is one of the first steps to get there, so.

Chris: The residential tends to be a little first step as far as the four plexes, three plexes, we see a lot of that just because there's some comfort there. And I think there's always a default in the back of all our minds, "Maybe, maybe this is just me, well if things ever get really bad, I can always move in there."

Josh: Oh, right.

Chris: You know what I mean? So it's always easier to make that you're first, but I think we hear a lot. Of course, people start coming in our direction when they suddenly say, "I just cannot take another middle-of-the-night phone call." Or whatever it is. Even if my property manager is telling me that this is a problem, this is a problem, this is a problem, whatever it is, there's not that pride of ownership that normally tends to be there for commercial. You end up having somebody whose business is there, so they want it to look nice, and then they go at 5:00 o'clock typically, and so you don't get those calls in the middle of the night. You get them the next day.

Josh: Man, you're speaking. You're speaking to the choir on that one. My wife fired me from property management. She really did.

Chris: Is that one of those selective incompetents like, "No, I'm really bad. You're taking over?"

Josh: I'm really bad. Well, actually, what happened was there was a house, the person wasn't paying, and so my wife's like, "You need to go over and talk to them." And so I went over to talk to these folks. And it was a really, really good story. So I ended up... The story was so good I gave them a hundred bucks. And I get back to the house, and my wife, of course, is saying, "So how did it go?" And I'm like, "It didn't go so well." She's like, "What happened?" I'm like, "Well," I say, "I gave them a hundred bucks." "You did what?"

Chris: "They're really nice people."

Josh: Yeah. So I got fired by my wife, and we hired a wonderful property manager in town to manage all our properties. And our marriage has improved tenfold on that decision alone because managing stuff can be stressful. You work all day long, you're tired, you get home at night, and then you start getting calls about fixing toilets, sinks, fans, and lights.

Chris: I know.

Josh: And those aren't any fun. So for those of you that are still in the trenches doing it, consider talking to somebody.

Chris: Yeah, yeah. We don't do it, but I find that there's no perfect manager out there. I mean, I love all the managers I work with, of course, but it's tough, it's a tough job, and there's a lot of turnover there 'cause you just don't ever get a phone call of someone saying, "Hey, by the way, I just wanna tell you how much I appreciate you, thank you."

Josh: Right.

Chris: It's either the landlord wondering where something's going on or, "Is this done?" Or "Why didn't I get this check?" And then it's the tenant saying that something's wrong, whatever it is.

Josh: It's a fairly thankless profession but very much needed because everybody needs a place to live. Right? Well, this has been a fantastic opportunity to have a conversation with you, I appreciate it very, very much. If folks wanted to get a hold of you directly, what would be the best way for them to reach out to you?

Chris: My direct line is 530-226-1160, or my email is [email protected] - C-H-R-I-S H-A-E-D-R-I-C-H. Those are the easiest ways. Or, obviously, through you and whatever else you guys are doing.

Josh: Absolutely, yeah, we'll definitely direct in your direction for sure. But everybody that's watching today, we want to thank you for your time, Chris. Thank you again. Appreciate you very much.

Chris: Thanks for having me. Yeah, thank you.

Josh: And have a great day.