Commercial Deal A Good one?

Question

Hey guys. I am a residential agent but have very limited knowledge on the commercial side of things. I have a commercial building that I am considering purchasing. It is the building that I am currently renting an office space at. The owner is willing to sell and here are the details.

Sales price 950k, the owner is willing to take a second position on the down payment the bank would require so let's say 20% second loan position for the owner.

The yearly rental income is $126.9k

Expenses are 48k

NOI is 78.8k

7 tenants are locked in until 2024, 5 are month-to-month, and 2 have leases ending by Dec of 2023. Built in 1991 and would say it doesn't need anything major repair at the moment.

Any other info you may need please let me know, would this deal be worth it?

Junior Francica · Answer

As far as my understanding goes, the owner would put the 20% the bank requires and take a second position so not technically 100% as far as the bank is concerned. But yes doesn't seem to make sense with the cash flow being so low not as good of a deal. Appreciate the feedback.

Benjamin Aaker · Answer

First, I would say that office poses a risk right now. Sounds like every tenant you will inherit will have a lease going month-to-month by 2024. I do believe office will be coming back but if you are going to purchase now, you will need to be able to stomach some long term vacancy. 8.3% cap rate seems low to me for office right now, but I don't know Chattanooga.

A way to minimize risk would be to make your offer contingent on the owner getting new leases signed for some of the tenants. Just make sure you run the numbers to see. Many office spaces have been vacant for over a year. If you can subsidize the expenses you might have a good property in a few years.

Ronald Rohde · Answer

I think is a deal with legs. Implement a plan to improve the appeal and raise rents. After you get it under contract, get permission to sign those m2m tenants to longer leases, show them your plans for making the building better.

If you can execute, then you have a greater then 10 cap deal that is cash flowing and generating real return on your equity. Is this a growing area of TN? plenty of small buildings can be fully leased and in demand, ignore everything else but your local market.

Brian Levredge · Answer

Are you renting an office or a separate suite from this owner?  If you are leasing just the office then I'd imagine you have full-service leases in place where the LL includes all utilities and internet and maintains the common areas.  Tenants typically clean their own office.

These buildings can be cash cows (but management intensive) so it really depends on the existing leases and how far under market the current ones are.  We typically spend a couple bucks bringing up the aesthetic, which helps push rents.

You will have higher turnover with this type of building, but like an apartment building these are typically not difficult to release in a short time.  If you run your own business out of the building you may be able to qualify for owner occupied commercial financing which is more favorable.  I'm getting ready to close on another one of these, but in full disclosure, if it weren't right up the street from my other one (where we operate from), I probably wouldn't do it.

Scott E. · Answer

NOI is $78,800. Debt service is ~$70,900 per year (JUST for the 1st mortgage)

This leaves you with $7,900 in annual cash flow. If you put $200k down that would be a 3.95% return on your money. Awful.

But to make matters worse you're talking about doing 100% financing on this deal. Not only will your bank not allow that, but if they did your cash flow would go negative.

Scott E. · Answer

If the owner does this they are going to put a lien on title in the 2nd position at closing (it would be crazy of them not to). There will be no way to hide this from the bank.

It's a bummer because on the surface it looks decent. 8.2% cap rate. Although some risk with those 2 leases ending this year. But yeah numbers don't make sense with 100% financing.

Account Closed · Answer

what kind of office, class b or c? Is it suburban or urban core, what's nearby look like, retail or office? not all office is suffering in dire straights, there's a good argument for suburban office especially nearby sfr and retail corridors. Tennessee has some very strong pockets.

Jude Campbell · Answer

Hi Junior.

You have some risk here with leases expiring.

You also have some potential upside on a few fronts:

1. If the landlord is currently paying expenses, it's structured more like a residential lease, which is odd.  Most commercial leases are structured as net leases: with multi-tenants, the only thing you should be on the hook for is property tax, maybe maintenance for common areas or external spaces.  CAPEX is generally up to the tenant, again, except for shared spaces and units should be individually metered, so you aren't on the hook for utilities.

2. The other upside is that you have control over rental rates, obviously subject to market but you could get a kick on both new rates and increases throughout the lease term.

In short, the current landlord looks like he/she might be selling this a bit short on current leases but baking in upside on the offering price, though I'd need more details.

I'll send a connection request if you want to discuss.

J

Gabriel Graumann · Answer

@Junior Francica Great questions. Beyond what a few others have already shared, the leases will likely be an issue for most lenders in the current market. Most lenders view a lease of 12 months or less as a potential vacancy as they is no guarantee that the tenants remain. If they don't gross income will be reduced which will increase their risk. What I'm seeing across the nation is much higher down payment requirements for office property unless you occupy 50% or higher of the gross rentable area. A more frequent LTV would be 30-35% in the current market.

A question I didn't see answered is why you are considering investing in commercial real estate. Is it just because you happen to occupy space in this building and want to "control" your rents, or are there other reasons? Have you evaluated this opportunity against other office buildings in this or other markets? While it might be a good deal for someone, it might not be a good deal for you unless it aligns with your overall investment strategy and how you need the money to work for you. Happy to connect if that is helpful.

Junior Francica · Answer

We haven't spoken about the 20% terms and yes would need to confirm with the bank that they allow that second position.

What do you mean by using another property as collateral?

Commercial Deal A Good one?

Most Popular Reply