Potential Investment - Medical Office Building on LoopNet

[Rakesh Battula]

Hey everyone,

I'm looking for some insights from the community on a potential commercial property investment I found on LoopNet. It's a medical office building located in Prosper, TX and here's a breakdown of the key details:

Property Details:

• Sale Type: Investment or Owner User
• Property Type: Office
• Property Subtype: Medical
• Building Size: 9,657 SF
• Building Class: B
• Year Built: 2023
• Percent Leased: 100% (Currently Fully Occupied)
• Tenancy: Multiple Tenants
• Building Height: 1 Story
• Land Acres: 1.00 AC
• Zoning: Commercial

Financials:

• Purchase Price: $676,000 + $81,000 Tenant Improvement (TI)
• Down Payment: 20%
• Commission: $22,000 (agent commission)
• Monthly Rent: $5,400 + NNN (exact expenses not specified)
• Vacancy (First 6 Months): Estimated expense of $27,600 (assuming rent starts after 6 months)
• Mortgage Payment Options:
  • 25 year term - $4,000/month
  • 15 year term - $4,600/month

Looking for Your Expertise:

• Does this fully leased medical office building present a good potential investment opportunity?
• Considering the new construction (2023) and current occupancy, is the purchase price reasonable?
• Are the lease terms favorable, particularly with the 10-year initial lease and renewal options?
• Are there any red flags I should be aware of, such as the vacancy expense or NNN costs?
• What additional information would be helpful to get a better understanding of this deal (e.g., demographics, tenant mix, operating expenses breakdown)?

I've been following the forum for a while and value the insights you all share. Any feedback or thoughts you have on this potential investment would be greatly appreciated!

Thanks,

Rakesh Battula.

[Nikolas Engel]

I will do this quick and dirty, only using DP and cashflow to analyze the deal. I assume that all expenses are covered in the NNN.

Out of pocket cost to purchase (DP 20%): $135,200

Monthly cash flow: $5,400 - $4,000 (mortgage) = $1,400

Months to recover only DP: $135,200 / $1,400 = 84.5 

It will take you about 8 years to recover your down payment. Only then you start making a profit. This does not account other expenses like TI, commission. If you add those out of pocket expenses it will take you almost 170 months to recover, that is more than 14 years.

This is a terrible deal! 

[Evan Polaski]

@Rakesh Battula, before even looking at the true financials like Nikolas quickly did, there are some things that don't make sense:

1: If it is 100% occupied, why are you assuming anything about free rents with estimates.  The lease should dictate any free rent dates, so there should be no assuming involved.  

2: If it is 100% occupied why are you paying any TI.  The seller who signed these leases would typically handle, and if it is not completed, then the lease is not official, as there are still contingencies for lessee to cancel if TI is not completed, presumably.

3: Why are you paying any of the agent commission?  Typically, this is a direct seller expense, but maybe you negotiated this directly.

As for your specific questions: medical office can be a great investment, if it is hitting your needs.  If this is an office building adjacent to a large hospital campus, even better, as it is very uncommon for hospitals to close down, so you will likely have strong long-term demand.

Given the occupancy, you don't have any real upside beyond rent growth over time.  So if you are happy with your returns, then price is reasonable.

Given you provided no information about exact location, no one can say whether lease terms are favorable.  Are you leases with larger corporate medical provider tenants?  Or are these tangential medical providers with no experience and bad credit?  How much vacancy and supply is in the area?  As noted, is this next to major hospital or off the beaten path?  All of this, and more should be assessed as potential red flags.

You should budget some vacancy, yes.  How much will be market and submarket and specific location dependent.  But even with 10 yr leases in place, it could take a year to find another tenant upon turnover, so that is 9% average vacancy.  And NNNs are going to be dependent on leases signed.  Is there any GLA that does not get included in common area?  Are NNNs truly covering things like RTUs, parking lot resurfacing, all landscape and litter collection, all common area utilities, etc.  Commonly, with multi-tenant buildings, there is some leakage in NNNs, even if it is things like tenant pays for maintenance contract on RTU and any repairs up to $5,000.  LL pays any repairs to RTUs over $5,000.

Tenant credit and experience, number of tenants, demand drivers for submarket, growth patterns in market, tenant sales (if these are more service medical providers like dentist or chiropractor) and this is being used more as a service center than back office work.

As for basic numbers, I would not call what you outlined as a terrible deal. Is the TI and commission able to be wrapped into loan?  Are there rent bumps over the 10 yr term?  Are there demand drivers that will keep tenants in place after 10 years?  Are the renewal options defined rent, i.e. 4x 5yr renewals with 10% bumps on each?  Are you in the path of development that will help appreciation of the property over time?

Assuming this is a true full NNN deal with good, quality tenants and you can finance your commissions and TI into your loan, you are earning a 10.8% cash on cash yield, using the limited numbers you provided. Your cap rate on PP is 9.6%, which is pretty good, if we are talking major metro, strong location, quality tenant base. And considering you are buying a property, all in, at $75/sq ft, that seems like a good price. That feels well below replacement, but again, I don't know the asset and construction quality, nor specific market and many other factors that ultimately impact value.