Hey Investors, Do You Know Your Vacancy Risk?
One of the fundamental errors in real estate investing is to ignore the risk of long term vacancy. Everybody knows to look at zoning, property prices, rents per square foot, etc. But high vacancy rate is an often underappreciated key to making profitable long term investments. More than a few real estate investors have been ruined by vacancies, which is why I value risk of vacancy over the potential for high rents. Investing in real estate is a long game, and tenant stability is a top priority.
It’s the details that keep your property occupied. Some are obvious, like whether a retail space is attractive and in a high foot traffic area. Others are trickier, like whether the layout of an office is aligned with current trends. You have to think about each individual property from the tenant’s perspective.
For industrial buildings, are the loading docks, ceiling heights, and storage areas easy to use? Does a restaurant kitchen have an efficient layout? Is there enough parking available? Even when things are good enough right now, try to imagine how they might look in the future. For example, a small parking lot might be OK for the current tenant but limit your pool for potential new tenants down the road. These details can be the difference between a property with high tenant demand and a money pit.
Local trends are another important consideration for getting on the right side of supply and demand. The implications of the city and regional economy are obvious, but the best investors dig deeper. Are there vacant plots of land or derelict properties available nearby? Is it easy to change local zoning rules? If so, you may face unexpected competition from new or repurposed buildings. Similarly, other neighborhoods in the area might lure away your tenants with cheaper options. Many investors focus too much on today’s rent while failing to account for the risk that this cash flow might not be stable in the future. Avoid their error by considering how the supply of competing properties might change over time.
Every once in awhile, I come across a golden-ticket property. One of my best investments is a San Diego grocery store with no nearby competition in a fully built up area. It checks all my boxes: As the only grocery store in a densely populated area, they won’t want to move away. Since the neighborhood is already heavy developed, there are no good alternative locations available for rental or new construction. My tenant and I both benefit from a stable long term relationship, so while I might be able to negotiate significantly higher rents, I don’t want to get greedy. Better to make modest increases over time and keep the cash rolling in steadily, year after year. But if for some reason my current tenant were to leave, I’d have a new tenant in no time at all.
Rapidly rising rents risk bringing new competitors into the market. If you’re looking to buy, beware the long lag time to complete new property developments. A word to the wise: Check the local public records for building permits. Too many permits for competing property classes could result in a rent-crushing glut of similar properties on the market. On the other side of that coin, complementary building permits (for example, new residential developments near where you want to invest in a retail property) can be a green flag.
Once you have done all your research, you’ll be in a strong position to make wise investments. The great investor Warren Buffett once said that “there are no called strikes in investing.” So remember that it’s infinitely better to pass on a good deal than to put your cash into a bad one. As long as you stay patient, there will always be another opportunity. Keep doing your homework, and when you find the right place for your capital, you will be ready to invest with confidence.
Call me at 847-317-0077, email me at [email protected], or tweet me at @benreinberg or @alliancecgc if you can submit us a property to acquire and/or would like to invest with us. For further information on investing with Alliance, please click here.
My Best,
Ben