Is it a good time to invest in Commercial Properties?

Question

I am about to sell another flip, and I have been deciding rather or not to buy a commercial property to flip, for the reason that the banks are wanting too much for dilapidated housing that has all turned too competitive to compete.

I am seeing some commercial properties now that can be bought with owner financing or ones that are dilapidated that seem to be good deals.  Is it the right time to buy commercial or should I wait for a while longer until the 7 to 10 leases expire on properties?

Of course I know, location, location, location....

I am just curious about the commercial property market at this time on rather it is a good investment or not?

Joel Owens · Answer

Edward for the right locations retail is very strong. Slated to grow by 4% in the next 12 months.

With areas in transition you really have to drive them. When we looked at a new development when I worked for a commercial developer we would scout sites. We would look at the product in the 2 mile to 3 mile radius for suburban. Urban core is much closer with changes in higher density.

If most of the centers are only 50% occupied and rents are stagnant then you have an oversupply situation especially if centers are older. Now in an area where growth is exploding it is common to have occupancy rates a little lower as pre-leasing is occurring pre-construction and mid-construction for the projects.

The area you are talking about I would want to know from the DOT what the traffic counts have been in the last few years prior and what they are today. I want to know if traffic counts are increasing year over year. The reason is I know certain retail tenants wait until a specific minimum number of cars per day is achieved for one of their metrics. I would also want to know if counts are higher the going to work side or coming home side. Different retail tenants would find one or the other attractive with their business models.

Look around in that area and see if any new projects are slated and is it starting to change positively. A good sign is new buildings going up and tearing down old ones. Get a copy of the current and future land use map to see what the county or cities vision is for today and into the future. Look at permits and site plans submitted for the area with upcoming projects. Some counties and cities have this online but smaller you might have to go to their office to get.

The gas station from the 60's likely has tanks that have been leaking for a VERY long time. Older tanks were not insulated well like the new ones today. You would be responsible per the EPA to clean it up and you have to keep digging and re-testing until you get clear margins on the soil all the way around the site. Some states or local authorities have EPA funds type program to offset the costs of clean up. You would have to check for that area.

Next is how big is this parcel?? Most old gas stations were sitting on a half an acre. The new super gas stations today sit on 1.5 acres.

If you have more usable land you have better resale ability. If you only have half an acre on the corner without assembling the parcels around you then you are limited on resale more. Typically the businesses that pay the most for the corner are a pharmacy ( CVS, Walgreens, Rite Aid ), gas stations ( Race Trac, Quick Trip ) , banks ( nationals pay a premium for a great location ), restaurants  sometimes will want the corner but often they do not want to pay corner money and want to be down just a few spots and then get off traffic with easements from the corner property and a center behind them etc. Sometimes a developer will take the 1.5 acres and put a 2 or 3 top on it for corp. tenants and sell NNN.

If you have just a 1/2 acre and no land assembling around you then your retail targets change. Remember the land needs to be useable. You could have 5 acres and 1 is flat. the rest goes off a cliff almost the topography is so hilly. What you are left with is to make the land useable you might be spending 200k to 300k an acre leveling it versus 50k for minor topography corrections. The land might not be useable under any situation and you are paying extra taxes each year for nothing.

Joel Owens · Answer

Edward most of my clients are not buying in the rust belt states.

Even if they live there they do not want to invest there long term. Unless you are in an urban core city most of the outlining suburban to rural towns in rust belts states are dying off.

The reason is very simple as the population ages with over 25 million retirees they are flocking to warm-belt states. They do not want the cold harsh winters anymore at their ages. With this migration of population patterns the retirees bring a boom to the economies fueling growth. So places like Texas , Tennessee, Florida, South Carolina, North Carolina, Georgia, etc. are hot for growth.

The rust belt states the outlying areas that are dying have declining populations, high unemployment, more people daily jumping onto government assistance programs. These counties and cities are bleeding money so they raise taxes to compensate which cause even more businesses to close and move to more promising areas. Mom and pops might stick around but big corp tenants just shut it down and will if they are left in primary term of the lease just sub-lease until the term runs out. This way most of their lease obligation is covered by the sub-tenant and now they do not have negative costs running their store there day to day.

If a town is dying then you just need to know your lease up tenant will be local mom and pop and not able to pay much so you have to build that into your numbers.

Joel Owens · Answer

Forgot to mention Edward getting off the interstate ramp you need to see traffic patterns for where your property is located versus the other side. I have seen instances where traffic count from interstate is 100,000 cars a day. You exit the interstate and go right from a certain direction and all these new buildings are popping up and traffic has gone from 9,000 cars a day to 15,000.

Conversely on the opposite side when you hang a left that side the traffic counts have stayed the same at 6,000 cars a day. No public water or sewer is available yet on that side. Most are running on private systems etc.

You just need to make sure you are IN the growth and not on the outside looking in hoping eventually they come your way. You could be waiting a very long time for that.

Richard Dunlop · Answer

I'd stay clear of that one.  To remove the tanks and clean the property, is there any limit to the possible risk?

Joe Cummings · Answer

1960's gas station with UST? I'll guarantee you that it's contaminated. In fact, I'll bet it's contaminated surrounding properties by now.

Joel Owens · Answer

Just too much risk for my taste.

If you already have millions say 5 million and your capital exposure with this project is 500,000 to land non-recourse finance then you have a 10% overall capital risk.

If you have 1 million and you are dropping 500k then a 50% capital risk.

Most of my high net worth clients stay away from these types of properties. You are gambling on XYZ to happen to get your return. People with a lot of money generally have a small percentage of the portfolio in high risk properties. This way if it tanks it doesn't take very much time to get that capital back with cash flow or equity growth from other investments.

Edward Briley · Answer

Joel you failed to address the second option I have been looking at for awhile now.  After I buy the building, and start the renovation on it, I am sure (I know) that this will set the city in motion to do the upgrades in their master city plan.   Maybe I am just afraid after seeing millionaires being turned into paupers after the last housing collapse.  I am worried that this will happen in commercial real estate, by me seeing what I am seeing.

Joel Owens · Answer

You have to forecast out your time horizon and see if the risk is worth the potential reward down the road.

Big corps typically do not want to be next to church's ( traffic and political issues). Funeral businesses are also a negative draw for traffic to retail.

I just think church, funeral, and EPA issues is a ton of obstacles to overcome. Seems like there is lower hanging and sweeter fruit out there to pick. Probably why others have passed on those as timing isn't right yet. Developers like to hold as least as possible until they see their full returns.

Edward Briley · Answer

Joel, let me explain what I am looking at here.  First of all the interstate traffic flow is no less than 50,000 cars a day (much more likely 100,000 or more).  Both directions have about the same amount of traffic flow.   Maybe much more seeing how the destination is to the Outer Banks of NC in the summer.

One way off the interstate is mainly to a high retail area that is about 4 miles away.  That way is mainly industrial and there are a Wendy's, Hardees, and McDonalds.  No GAS that way until further down - a lot further down.  The place I am looking at is about 3/4 acre.   The building that is setting on the property was last used is some kind of computer data entry center.   The building is 1,400 sqft, and brick, really decent looking.   A gas station and conveint store basically share the intersection it sets beside.  (Other words basically 2 gas stations, one sells diesel, the other does not.  A Private church learning center sets beside this property, and a funeral home sets across the street from it. (They looked into buy it, however, were too concerned about the tanks in the ground).  I know my options with the tanks.   Further down is residential that is in another city.  Like I stated before, I know the property will reap a profit today, but I am not sure how long it will be before it becomes something really worth owning or not.  This is just one option, that is very, very cheap.

Second option, building that is about 9,000 sqft that sits on a major thoroughfare, close to the water.  No flood insurance required.  This building has been vacant for 7 years, and belongs to a family trust.  It is Cement Block Constructed and was used is light industrial.  This building sets beside, and is in one of the better residential areas in the City.  The problem is renovation.  The cost to acquire it is almost too low for anyone to believe.  The problem is renovation.   The land is worth the cost - not the building.  You know these traps, cost more to tear the building down, than what the land is worth.  The building I know can be renovated for less than $100,000 to meet the cities future planning project, that was delayed due to the real estate disaster, however, when this does happen or ever happens the building will be prime real estate.  These are my dilemmas, I don't see anyone else jumping on these properties, even though they seem to me to be very good investments. Again, is it a good time to invest in commercial properties?

David E Gardner · Answer

Buying in a down market can be great when the area has a strong economic base & good employment.  However, as Joel pointed out, buying in a down market with a weak economic base & poor employment can be more like trying to catch a falling knife.

So, you have to be careful & realistic on the returns you can get on a property in that kind of area.  It can be done, but you will have to deal with many more outside factors than in a desirable area (crime & vandalism, being one).

Personally, as I stated before in the previous questions, if I can't get quality answers to my questions from experts in that particular area, then I would walk away.

Is it a good time to invest in Commercial Properties?

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