Buy a negative cash flow?

Question

There is a small (625 sf) office space offered for sale for super cheap ($25k).  So cheap, I could pay cash!  I spoke with the Realtor and found the reasons:

1) interior office, no windows, not desireable

2) $6000/yr CAM (includes HVAC, gas, electric, maintenance of bathrooms, hallways, elevators, underground parking ["allotted," not deeded, parking space]).

3) Adding CAM, taxes and insurance, it would cost $700/mo to own (not including debt service).  That's $13.44/sf.

4) Glut of office space.  A local business moved their corporate HQ, tons of vacancy.  Interior office in fair condition is renting for $5-15/sf now, call it $10.

The purchase price is "soft," the owner probably just wants out from the ownership expenses.  One reason I'm interested is the overall strength in this resort area (Beaver Creek/Vail) and specifically the growth projections in the town.  The last sale in 2006 was for $140k.  One reason I'm not interested, buying a negative cash flow is moronic.

Does anyone have experience getting CAM fees lowered?

Would anyone buy a negative cash flow on anticipation of appreciation (both rent and future resale value)?

Ryan K. · Answer

Haven't met a traditional lender that will do 0-down on commercial investment property (exceptions for long-term relationships with mutual, substantial, solid investments).  Figure 20% down on regular commercial like office or retail, 35% on special purpose (lodging, car wash, etc).  Calculate down payment needed and payment on the 80% loan.  Recent local lenders have offered 3.5%, 5-year ARM or 5-year balloon with 20 year amortization.

For this example, bust out the HP12C and follow along:

$20000 purchase price, $4000 down pmt (no closing costs for example)

$16000 PV

3.5% g i

20 g n

PMT = $93/mo

In 5 years, the balloon balance would be $12,900, total interest paid of $2,320.

CF is same for comm as res.  Build an income statement:

$1875 + $7502 = $9377 PGI ($3/sf + NNN reimbursable expenses)

-$2344 v&c (3 months, higher because of oversupply)

=$7032 EGI

$7502 NNN reimbursable expenses (CAM, tax, insurance)

EGI less nonreimbursable:

-$703 r&r (10% of EGI, probably high for this unit)

-$1000 professional fees (CPA, attorney)

=$5330 EBITDA

-$1113 Mortgage

=$4215 NOI

11% Cap (+100 basis points for increased risk of interior unit), value = $38,330

If it could rent, I think it'd be good.  $1/sf = $50/mo, $2=$100, $3=150.  Small ball but a tenant to cover the NNN would be the goal and it would be cruise control additional income with appreciation potential.

Tom B · Answer

How do you figure cash flow when you are taking a loan out on a commercial property?  Is there a standard that says you should figure the cash flow with a certain percentage down payment or with 0 down?

Ryan K. · Answer

@David Krulac - As an appraiser, my job is analyzing deals and looking at how other people have made or can generate income from real estate.  In fact, I went back and revisited this listing, pulled some comps, and it looks like it could rent for a couple bucks per sf + NNN.  I believe the taxes are high because the county's value is far higher than list price, creating a potential abatement (refund) situation, which could help reimburse initial investment dollars.  The only thing is the whole thing is small ball.  Buy for $20k, rent for $100-200 income/month, get a $500 refund.

As a young investor, this could be an opportunity though and if rents appreciate back to $15/sf + NNN like they were in '06 or I could sell it for $120k in a few years, it would be a brilliant move.  Still small ball, but enough to get rolling and the lessons learned would surely be worth it.

One very attractive thing is its a 625 sf office/storage space.  It could take some creative marketing to get it rented but after filling the space, there would be zero maintenance, upkeep, headaches (always something).  Maybe a build a small reserve account for new carpet and paint in a few years but really nothing to break in this unit.

So, I am still interested in this deal.  It may not, in fact, be a negative cash flow.  I agree with the above posters that even a break-even deal would be silly, need to do some more research and walk the building, check out the other tenants -probably the best source for renting this space.

David Krulac · Answer

@Ryan K.

Why buy negative cash flow?  In the course of your business as an appraiser, you must be seeing many people who are thinking of selling or need cash aka refi.  surely you can find a positive cash flow situation for yourself.

Tom B · Answer

What about renting it out as a large conference room for all the other offices in the building?

Ryan K. · Answer

Thanks for the reply @Huy Nguyen.  I agree.  However, it is still tempting.  The area is poised for growth, they're giving the space away for free...guess it's another example of too good to be true.

Any brainstorms on a potential tenant that would prefer no windows?  Maybe storage but its a small space.

Huy N. · Answer

@Ryan K. ,

I would not by a negative cash flow ever on anticipation of appreciation. If market goes South then you will be in deep trouble.

I consider appreciation as my bonus, not my salary on all the deal when i do my number.

Thanks

Huy