To sell or not? If sell what to do with the cash?

Question

My sister and I inherited. 4 individual commercial properties all leased to Dollar General. They have about 10yrs left on their leases NN. Rent is $16,500 per month. The loan payment is $12,700 ,roughly 1.5 million left on the note.  It balloons in December 2016, my sister wants out and I honestly would prefer to not be in business with family. I spoke with a broker he said they could bring anywhere from 2.3 to 3 million. I'm rough estimating, I could walk with 200-300k. I'm 24 years old and I love working with commercial real estate and me and my wife would like to start my our own real estate holding company one day. I also currently have a 300k mortgage on my house, I've considered paying it off  with the sale proceeds if there's enough and saving each month what I was paying in a mortgage payment. The interest rate on my mortgage is 4.75% with 29 years left.  After I've saved for a couple years we start buying up some properties for ourselves. Or do we use that capital to start buying now? Looking for advice and opinions! Thanks!

Joel Owens · Answer

The salability of the property is all about the leases with NNN. Years left of primary dictates with lenders how much a buyer will need to put down LTV wise.

Being NN is also a negative. Depending on what is in the lease the buyer could be responsible for roof, structure, parking lot, utility lines etc.

If you just renewed usually Dollar Stores renew for 5 years even if they have 2- 5 year options. The only time they generally renew for 10 is if they have a sweetheart lease renewal or if the location is so good  they have monster sales over their nationals store average.

Used to you could get Dollar Stores 3 to 4 years ago for an 8 to 9 cap and they had 2% annual rent bumps. These days Dollar Stores are overvalued for my taste. They write 10 year leases on brand new stores at about a 6.5% cap rate with zero  increases in the primary term so doesn't increase until the option period. You generally have to put 25% down.

So if you put 25% down or 250,000 to buy a Dollar store you might as well try to by a pharmacy for 10 to 15% down instead. All brick building with 10,000 to 12,000 sq ft sitting on a hard corner where the land is more valuable. Dollar Stores tend to like less quality areas for their customer demographic . They tend to build a veneer front and sheet metal sides and back and be off the beaten path a little bit because they do not want to pay per sq ft corner money.

Having said that there are generally more buyers because they are cheaper to purchase. if  a Dollar Store goes dark the second generational tenant pays less for a sub-prime location. I have seen some cases where you can buy a strip center and the Dollar Store serves as a mini-anchor. So in that sense you get some stable income but the upside of the smaller retail units attached at higher rents for a blended cap rate for the center.

Joel Owens · Answer

"They have about 10yrs left on their leases NN."

The broker you spoke to you would really need to drill down on this further.

Generally Dollar General does 10 year leases for the primary term. So for financing if the Dollar Generals have 10 years left primary term that is very different from 5 years primary left and a 5 year option. The lenders will NOT count the options as they are not guaranteed.

Location and length of term on the leases will drive your exit cap rates of what they would sell for.

I would really need to see your leases and see locations to give an opinion of what might make sense to do. It's all in the details with NNN.

Martin Z. · Answer

I would try to keep 2 of them, and retain for long term hold, but I guess that arrangement with your fam member would work out if they're collecting similar rents, and in comparable area. Plus, if you cashed out, you'd probably have a large tax liability on the capital gains, check with your CPA>

Michael R. · Answer

Why not buy your family out either now or over time?

Joel Owens · Answer

The whole single tenant net lease sector is compressed right now. Most of my clients are buying strip centers.

There is about 300 billion in CMBS coming due between now and 2018 for vintage loan opportunity buy outs.

NNN does trade for slightly lower basis premium on the cap rate. More of a factor is any rent increases in the primary term of the lease for the overall blended cap rate over time with inflation. If NN buy cap is high then it can offset other factors. Sometimes sellers will buy a roof warranty to appease the buyers for a purchase.

Food has the most rent bumps at 2 to 3% annually but also those go dark the most versus banks, dollar stores, auto stores, pharmacies, etc.

Account Closed · Answer

@Joel Owens Correct, the 4 DG'S were owned solely by my father and the three strip centers were owned by him and my mother until he passed. They divorced 4 years before his auto accident. We're not currently looking to sell the strip centers. Everything we own is in Alabama.  I wouldn't be opposed to NN deals over NNN, if it's the right type of deal, as all of our current holdings are NN and don't you pay a premium for NNN's ? I want it to be business,  it doesn't necessarily 100% hands off as I have the time to work it.

Joel Owens · Answer

So Ryan your family owns three strip centers as well??

4 DG's and 3 additional strip centers??

5 year extensions the lender is going to want more than 25% down generally. The reason is they do a DARK appraisal value before they lend. They want to see in year five if DG vacates what the cold dark shell value is to liquidate in case of borrower default. They want that number at or below the projected loan balance based on amortization schedule at that time. In this way the lender has some legal costs but gets out of the property with almost the loan made whole.

In these cases 40% down or more is required because of the short term of the lease. Right now interest rates are low. If you hold this down to a 2 to 3 year lease remaining with higher interest rates the sell cap for your building will have to increase and your equity will erode.

It seems to make more sense to cash out while buyers are bullish on them with low interest rates before they fall out of favor. Investor sentiment changes year to year based on market dynamics of different assets classes and even subsets of those classes to be in a buy, sell or both position.

NNN food you have to be very careful on that. Most Dollar Stores are BBB- rated or better which qualifies for investment grade lending. If it's below BBB- it is credit grade. 5 different levels of security for restaurants.

Example Taco Bell: Lease guarantee best to worst.

1. Yum brands parent corp. guarantee for all stores backing your location.

2. Subsidiary of Yum brands say for just that state of 200 stores etc.

3. Large franchisee with 100 stores with decades as an operator.

4. Small franchisee just starting out with a few stores.

5. No franchisee at all but an operator starting their own brand with no guidance ( Joe's taco's ).

What states are your strip centers in?? I always am looking for myself and my clients.

Account Closed · Answer

They were 5 year extensions.  If we sold, I wasn't really wanting to buy another DG property. I've looked at fast food NNN, really like pharmacy NNN or some type of multifamily. My only experience has been with single tenant commercial and strip centers as we have 3 of those as well.  So I'm a little hesitant on moving to residential.

Erik Nowacki · Answer

I would not pay off the residence as you should be able to get a much higher cash on cash return from your investments.  There are a few schools of thought on this subject, one of them states that you become a larger target for lawsuits if you own your house free and clear.

Net leased commercial property is usually a good retirement investment, but it only builds equity with falling cap rates.  If cap rates increase, the value of the net lease property will fall.  In your shoes, I would be concerned about cap rares increasing in the future, wiping out your equity.

I would look into splitting up the properties between yourself and your sister, then sell your buildings and do a 1031 exchange into another property, commercial, multifamily or residential, whatever you feel comfortable with.

So long as you are making money from your investments, is it really that cumbersome to write one more check for your mortgage every month?

Good luck!

Erik

Randy E. · Answer

@Ryan Watson, one thing to consider about paying off the mortgage for your primary home.  If you're going to dig into details about comparing the mortgage interest rate to the savings account interest rate, don't forget tax implications.  With the mortgage, you're able to write off the interest payments as a deduction.  Because your mortgage is basically brand new, that's a lot of interest on a $300K mortgage.  When calculating your plus/minus regarding paying off the mortgage, don't forget to account for that.

To sell or not? If sell what to do with the cash?

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