Need help making an offer

[Bob Langworthy]

I'm sure that I'm overthinking this. Here's the situation:

A friend let me know about an off-market office building owned by 6 individuals that are interested in selling. They have owned it for 15 years, are in their 80s, and don't want to deal with the challenges of leaving it to the next generation. A stated reason for their interest in selling is that two buildings just down the street from them sold in the last two months. One for $800,000 and the other for $1,100,000. Those properties were listed with commercial brokers that gave NOI showing that they sold for cap rates around 8%.

The property I'm interested in has 9 offices with one currently vacant, but they have done a poor job with keeping up with the local rental market and only have NOI of ~$25,000. "Simple!" you say. "Divide the NOI by an 8% cap rate and the building is worth $312,500."

Here's the sticky part: they paid $455,000 for the building and have put ~$80,000 in to it. They are not sophisticated investors and have dollar signs in their eyes due to the properties down the road.

My conversation has been with one owner who more-or-less represents the others. So here are my questions:

1) Should I offer what the calculator says I should offer? 

2) Try to educate them on commercial property values?

3) Should I run a pro forma and assume rent increases (6 of the 8 current leases expire this year) and base my offer on what I expect next year's NOI would be? This property is on the best street in town for professional offices and is right next to a ritzy New England liberal arts college. Rent increases would not be difficult.

4) Owner financing. How would you structure it?

Background on me: I'm an accountant. I own a 4-office building in the same town that is fully occupied.

Thanks for your help!

[Russ Draper]

First of all, only offer what makes sense to you.  Don't try to fudge the numbers to make it work hoping everything is going right.  If the numbers show its only worth $312k then that is your max offer.  It doesn't matter what they paid for it or what they put into it, only what the market shows its worth!

I would try education and show that the buildings need work, they may not believe you and list anyway, and then sit on it hoping for a more gullible investor to take it, and then after a few years come back to you!

[Brian Schmelzlen]

Hi Bob,

I would start off by trying to educate them, so that they would at least be more willing to continue to negotiate.

Paying them $535k+ would just be ridiculous given their NOI (if they want to put in the work to improve the NOI before selling to you that is different, but don't pay them for work you will have to do). However, it may make sense to pay them more than what the property is worth based on the income method IF they give you amazing owner financing terms in exchange. If they were willing to charge you interest close to AFR rather than market, it may be worth overpaying for the building especially if you can get it cash-flowing quickly.

[Bob Langworthy]

Thank you @Russ Draper and @Brian Schmelzlen. I'm going to go with the education/owner finance route and make two offers. Offer A: $325k with bank financing. Offer B: $400k total with owner financing paid at $15k/year for 10 years and a lump sum in year 11. We would work backwards into a principal/interest split.

The $325k with bank financing would cost ~$460k over its life.

As I mentioned, there's a ton of potential with the building. My own building is 2800 sq.ft. with gross rents of $63k/year, while this building is 3500 sq.ft. with gross rents of $53k/year. Adjusting rents would add to the NOI and justify a higher purchase price.

But I also think I'm emotionally attached to the building because it's a beautiful 100-year old home in a prime location. That's clouding my thinking a little.