Niche properties

Niche Nosh

These brokers get a taste of success with unique investment opportunities.

What’s the No. 1 down-market strategy from The Donald’s blog, Inside Trump Tower? Explore overlooked niches.

And what could be more overlooked than boutique hotels catering to the gay and lesbian community? That’s where Jaime M. Rook, CCIM, broker and owner of JMR Real Estate in Palm Springs, Calif., found his niche. As the owner of a specialty hotel, Rook discovered that “there was a need for proper representation. Commercial agents in [the Palm Springs area] were not able to provide financial information that included internal rate of return, capitalization rate calculations, and all of the information necessary to adequately represent buyers and sellers,” he says. He moved to Palm Springs, home to one of the country’s largest gay and lesbian populations, to focus on representing buyers and sellers of specialty hotels catering to that specific demographic.

Inndulge Inn is one of 40 boutique hotels in Palm Springs, Calif.

Rook is among a number of CCIMs who have discovered their unique place in the commercial real estate universe. Whether it’s mining a new demographic, developing a new investment product, or carving out a niche within a niche, these commercial real estate professionals know the value of being equipped to exploit the intersection of luck and logistics whenever it appears.

Finding a Niche

In commercial real estate, niche approaches include promoting a new investment product and catering to a new investment clientele, as well as a combination of both. For example, Mark Alexander, CCIM, senior medical office adviser at Sperry Van Ness in Fort Myers, Fla., has matched up a specific clientele with a specific product in a specific locale. “Private investors doing 1031 exchanges have voracious appetites for medical office buildings in small to midsize markets in the $500,000 to $4 million range,” he says.

Alexander has sold more than 50 triple-net-leased MOBs to 1031 investors and has the profile down cold. “Ninety-five percent of these investors are at or near retirement, are conservative in nature, have moved to the Southeast, and are looking for management-free investments where they live,” he says. At the same time, the retirees’ migration has increased the need for MOBs in smaller communities in the Carolinas, Florida, and Georgia. “In small towns, just look at the streets around the hospitals. These MOB markets have a long history of stable occupancy by MDs that investors find so attractive.”

Jeremy Doyle, CCIM, of NovaSource in Salt Lake City also has developed a specific product that appeals to the 1031 investment market. “NovaSource’s core focus is … multiunit expansions of stand-alone pad retailers,” he says. Doyle works with corporate tenants such as Starbucks, Washington Mutual, JustBrakes, and CSK Auto as well as franchisors Jiffy Lube and Sonic Drive-In. “We handle site selection, land acquisition, tenant lease, building entitlements, construction, and the eventual sale of the property. At any one time we have about 30 projects under development in the Western U.S.”

After the tenant is open, NovaSource sells about 85 percent to 90 percent of the developed properties, usually to the 1031 exchange market, which, “until last summer had been very strong with low sales cap rates,” Doyle says.

But the housing slowdown and subprime lending crisis, along with increasingly high construction and land costs, put a crimp in the retail build-to-suit market, he says. In addition, “selling cap rates increased at least 50 to 75 basis points over the previous year, substantially decreasing profit margins.”

So NovaSource tweaked its MO and decided to acquire rather than build for a Jiffy Lube client. “In the Saratoga Springs, Utah, market, NovaSource was able to acquire an existing quick lube real estate, secure a non-compete from the operator, and lease the property back to its Jiffy Lube client,” Doyle says. In addition, Jiffy Lube opened the same day NovaSource acquired the property, had no zoning issues, and became the only quick lube shop in town. Plus, NovaSource acquired the two-year-old building at less than replacement cost, which translated into a lower rent.

It also was a win for NovaSource. “The building acquisition for Jiffy Lube was so appealing to NovaSource because it had low development risk, no cost overruns for new construction, and quick turnaround in an uncertain market,” Doyle says. “Plus, I had presold the property to a 1031 investor before NovaSource purchased the property, which locked in the profit.”

While pad-site retailers are slowing their new development plans for this year, many still are looking for existing pad sites in established trade areas, Doyle says. “And the 1031 market is still relatively strong with buyers still looking for good product even though financing triple-net-leased properties has been more costly.”

Many pad-site retailers have switched their focus to acquiring existing sites in good locations to curtail development costs.

Alexander also hit a slowdown in his niche, which includes many sale-leasebacks. “In the past doctors could personally guarantee their MOB lease as part of their sale-leaseback transaction but that has changed.” Since December 2007, he has had more than $18 million of MOBs closing or under contract. “Those investors with good credit seem able to lock in better interest rates right now, but they are made to jump through more hoops than ever before to secure the financing,” he says but sees this as a minor hitch. “MOBs sit squarely on the runway of this turbulent market’s flight to quality. The long-term view for MOB market growth and demand is quite good.”

Marketing a New Product

Finding a new type of product to sell or manage for investors is another niche strategy, one that is working well for Douglas K. Smock, CCIM, a principal at Springwood Property Co. in Atlanta. “Springwood specializes in the acquisition, management, and sale of higher-and-better-use timberlands for institutional clients as well as high net worth individuals,” he says. Springwood currently manages about $40 million of HBU holdings for its clients. HBU timberlands became available in the 1990s when large publicly traded paper and wood product companies started selling off their land holdings to boost their bottom lines. “Stock prices were becoming increasingly depressed due mainly to the fact that these companies were required to carry these huge land holdings at book value,” Smock says. “They realized that they did not have to own all of the lands to stay in business and by selling off these highly appreciated assets they could increase liquidity, reduce debt, and boost share prices tremendously. So really, the opportunity has been created by the relatively recent availability of these lands to the private investor where they were not before.”

Smock estimates that about 7.2 percent of the 248 million acres of privately owned U.S. timberland meet the HBU criteria, which is land directly in the path of development. While investors profit from leasing timber rights back to the paper and wood companies, “Ultimately returns are driven by appreciation of the underlying value of the bare land,” Smock says. The typical investment size is around 100 to 300 acres, with prices ranging from around $3,000 to $10,000 per acre, and a typical hold period of three to five years.

Like Alexander and Doyle, Smock sees a lot of interest from 1031 investors. “The goal for the HBU client is one of higher returns over the life of the investment,” Smock says. However, “implementation of timber management plans that maximize financial returns while improving site conditions, access, and overall aesthetics, enhancing value through selective capital improvements, and well-timed dispositions” require a specific knowledge of the forest industry, as well as local land use and demographics growth.

More than 35 million acres of industrial timberland has changed hands in the last 10 years, most of it located in the southern states, shifting ownership from paper and wood companies to institutional and private investors, according to forestry experts. Although the current housing slowdown has curtailed the demand for residential development land, HBU timberland is still in demand as an asset. Long-term, institutional investors plan to add as much as $4 billion in timberland assets to their portfolios, about a 10 percent increase from current holdings of $35 to $40 billion, according to a September 2007 Merrill Lynch study.

A Niche Within a Niche

Sometimes a niche is doing what no one else wants to do. Eduardo F. Bello, CCIM, managing broker of Bello Realty in Kihei, Hawaii, and Breckenridge, Colo., focuses on resort retail in those two tourist meccas. “Many resort areas do not have an established cadre of commercial practitioners since the markets are small, and high-priced resort and second-home properties are sexier and provide high-commission income. Many residential brokers do not want to bother with leasing and commercial business so they will gladly refer their high-end clients.”

Lack of cookie-cutter architecture and standardized space locations is one of the challenges of leasing resort retail.

Since the early 1980s, Bello has developed, managed, and leased several shopping centers, including acquiring an old convenience store and redeveloping it as a 10,000 sf historic theme retail center. Currently Bello is developing a retail mixed-use center in downtown Breckenridge that includes restoring a 100-year-old riverfront home and building a historically compatible commercial center on the site.

Bello finds little competition in his markets. Both cities are mature markets where land costs are high and new development is discouraged. Leasing has challenges too. “Accurate, reliable demographic information sources can be difficult to obtain,” Bello says. “For example, a resort area’s census info may show a small permanent population with many low-paying service jobs, but in reality you may have a huge volume of tourists or second-home owners with tons of disposable income that is very hard to document.”

The lack of typical demographic information makes it hard to lease to national credit tenants as does the diversity in architecture, Bello says. “In Breckenridge, most retail locations are in a historic district that does not allow the sizes and styles that national tenants demand. They are hard to sell to since the available space does not meet their cookie-cutter criteria,” he says. “In Hawaii, where land costs are high and lots are small, it is virtually impossible to find a free-standing pad, and many potential tenants balk at the high rents.”

But regional and niche retailers often find good opportunities in resort areas. “Some fast-food and convenience-food operators recognize the validity of these markets and will go into smaller locations with features such as no parking and second-floor seating that would nix a mainstream deal,” Bello says. “We also find good operators [who are] willing to open multiple locations. For example, a successful shop on Kauai [Hawaii] may want to open another location on Maui [Hawaii]. A restaurant with a following in Denver may look to open another location in the mountains where many of their patrons go for the weekend or own second homes.” With projects in both tourist-friendly markets, Bello is still seeing strong demand and rents that are “at least moderately increasing.”

Catering to a New Client Base

While the number and diversity of 1031 investors has created a market for numerous niche products, there are other client bases available. Due to the devalued U.S. dollar and the U.S. real estate market’s reputation for stability, foreign investors are showing great interest in U.S. properties, according to Manfred Chemek, CCIM, chief executive officer of Manheim International, in Aurora, Colo. Chemek, who works with private high net worth clients as well as foreign financial institutions, has seen interest from investors around the globe. Many are from northern European countries, as well as Russia and Israel, Chemek says. “Australia is a strong investor in the U.S. because of limited opportunities at home. Japan is coming back. China, Korea, India, Saudi Arabia, the United Arab Emirates, Canada, Mexico, Colombia, and Brazil” all have investors interested in U.S. real estate.

Office properties in Washington, D.C., top the acquisition list of his international clients, Chemek says, as well as strong markets such as Atlanta, Dallas, and Houston. “Now some astute investors also are looking at third-tier markets because of less fluctuations and steady growth,” he says.

Foreign investors hold $230 billion of U.S. real estate, according to the Association of Foreign Investors in Real Estate. AFIRE’s 4Q07 survey showed foreign investors completely reversing last year’s property preferences, choosing retail, hotels, industrial, and multifamily over office, last year’s No. 1 choice.

Chemek concurs. “Investors are looking at good returns in the retail market; also multifamily is coming back in demand and will be strong in 2008.” And this year, investors surveyed plan to make more than 50 percent of their acquisitions in the U.S., about a 16 percent increase in the dollar amount spent here, according to AFIRE.

While Chemek hopes to mine his international CCIM connections to gain worldwide clients, Jaime Rook has narrowed in on the very specific market of Palm Springs boutique hotels that cater to the gay and lesbian population, also known as GLBT or gay, lesbian, bisexual, and transgender. “Most of my work to this point is in Coachella Valley [Calif.],” Rook says. There are approximately 40 hotels in the valley that cater to either the GLBT community or a nudist clientele. “I would say that the properties resell about every seven years on average. However, I would like to represent buyers/sellers throughout California that are interested in this specialty product.”

Rook’s company has closed more than 100 transactions representing both hotel and apartment owners, and his specialized knowledge of this niche brings him calls from appraisers and bankers in the area looking for his input. “Many times appraisers find me through the CCIM directory or LoopNet and call me to ask my opinion of a property’s value.” Currently properties in Palm Springs are valued at around $100,000 per key, although he recently sold one for $215,000 per key.

While Rook has chosen a very specialized niche, it is a fairly large part of the Palm Springs demographic. “Palm Springs is a very gay friendly city, which adds to the value of the assets,” Rook says. “Gay tourists feel very comfortable here. The mayor and two of four city councilpersons are openly gay,” he adds. Palm Springs’ population is estimated to be more than 55 percent GLBT, “but there are no other commercial agents that specialize in representing gay hotel owners,” Rook adds.

Rook is zeroing in on a niche population that is steadily growing. The total buying power of the GLBT adult population was estimated at $641 billion in 2006, according to Witeck-Combs Communications, which compares favorably with more-traditional ethnic populations. And although few cities match Palm Springs’ estimate of gay population, six U.S. cities have GLBT populations greater than 10 percent.

In a sense, commercial real estate is all about niches. Every property sector can be sliced and diced by geography, use, income, or investment. Investing in or at least investigating new business opportunities is a chance to jump-start a stalled sales volume or create an additional revenue line. And it makes great business sense. Like dividing a property portfolio among several geographic markets, it spreads the risk while increasing opportunity.

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