My First Commercial Building Deal - Your thoughts?

Question

Hello all,I have just bought my first commercial building and would love your thoughts on it! Deal and building stats below. A bit of context for you all, I am 28 years old and this is my first real estate deal. The seller of this building is 72 years old and wanted out so he could move to somewhere warm. I saw it the day after he called the real estate agent and put down a deposit two days later after doing my due diligence.Deal Stats Purchase Price: $950,000 (owner wanted $1,000,000) Down Payment: $250,000 Mortgage: $700,000Mortgage Years: 15Rate: 5% fixedMortgage: Previous owner is providing the mortgage though i can get a mortgage from a traditional bank at any time and repay him with no penalty. Good flexibility for me. Want to see where rates are going to go.Building StatsBuilding Type: Light Industrial building with good roof, large laydown land surrounding the building (good for big equipment and trucks) and a brand new fence encircling the property. Building looks brand new.Size: 6,350 square feetAnnual Rent: $76,200 Lease Type: Triple net lease (NNN) - No costs for me to bear at.Tenants: 1 Tenant - Global industrial company (Worth over $20 billion - listed in London)Lease Period : 3 years with two 3 year renewal options (10% rent increase per renewalPrevious tenant: Was another large industrial company, they left 6 months ago and moved to a new building. I went in and asked to speak to the manager and asked why they moved, was there any problems with the building etc. He said the building was fine. No issues ever. They moved because they needed a bigger space (there new building was double the size).My calculations indicate that by putting the excess cash generated every month against the principle, I should be able to pay it off in c.11-12 years.Would love any thoughts the collective BP community has!!

Joel Owens · Answer

From your profile it appears you are overseas and so is the property.You mention the mortgage is 15 years but do not say whether that is the loan term, amortizations schedule, or both.You could have a 15 year loan term but a 30 year amortization schedule making the monthly payment less. It increases cash flow off of the down payment and gives you more flexibility with what to do with the cash flow.Example with a 15 year amortization you have to make a very high monthly payment versus a 30 year you have options to pay extra at your discretion which helps with the ebb and flow of a property more. For instance when a tenant decides not to renew a lease and you have a dark period for an extended period of time that 30 year amortization with a lower monthly payment can sure come in handy.The price you paid is about an 8 cap. For industrial that cap rate is a little low at least here in the U.S. for where the cycle is at for that asset. Given the quality of the tenant it sounds promising. For NNN "Global industrial company (Worth over $20 billion - listed in London)" WHO is guaranteeing the lease??I see it often whereon flyers it mentions a so and so billion dollar company is the parent corporation. It means nothing. If they have set up a subsidiary company then the parent corporation generally is not backing the lease. I care about who is on the hook to back the lease and the lender will care if you go get a new loan. The lender will do an appraisal and look at a "dark value" meaning at the end of the primary lease term before options what is the value of the building in a vacant dark condition if the lender has to foreclose and liquidate the property??They want that number at or below the remaining mortgage balance at that time so they can almost get out of the loan unscathed or with very small losses.

Chris Field · Answer

How do you guys in this space deal with long term vacancies? I have always found properties like this fascinating, but I have also seen them sit vacant for sometimes years on end. The threat of a 1-5+ year vacancy quite frankly scares me. My uncle lost a good sized fortune in the late 80's building 100ksf+ of commercial space when the economy turned. The tenants simply started to fold up shop one by one after expensive fit ups and he was unable to make the debt service on the property. After he lost it, it really took a decade for that property to get leased out and stabilize.

Ash Patel · Answer

I understand wanting to pay off your mortgage early but look at the concept of cash on cash returns. Can you find ways to increase your cash on hand and start looking at another deal or were you thinking one and done?

Gary McGowan · Answer

For Alberta real estate those are pretty good numbers. As for the amortization on the mortgage, some lenders on commercial will do a max 25 yr most are looking at 20 yr in Canada and will require 25-35% down or equity based on their own conservative appraisal.

Joel Owens · Answer

For the size of the building the cost per sq ft is about 157. For current rent you are at about 12 ft.I do not know anything about Canada for real estate. In the U.S. 12 ft for rent on most Industrial property is high.I would be worried with a single tenant user at such a high sq ft if they vacate what will the replacement tenant pay? If might not be close to the 12. What kind of LC will you have to pay out to get it re-rented with additional TI requested.If the lease is really guaranteed by the parent corporation then it sounds great. Of course you have to look at out clauses in the primary term of the lease before the option periods. Lenders will take the out clause and say the tenant has an out even before primary term ends so the guarantee is weakened or they disregard it altogether for security.I understand your pay down method. I think opting for the 30 year loan and then saving that extra money as an earmark in case the tenant vacates makes a lot of sense.If it's a 10 unit retail strip center for instance I can have about 4 vacant out of 10 and still service the mortgage at a breakeven point with putting 25% down. This is why here on single tenant properties we like to see 10 to 25 year primary term leases for security.

Roy N. · Answer

@Bill HaywoodYou should be able to refinance with a tier 1 commercial lender (Big-5, Canadian Western, etc) for better than a point less than your private mortgage. I too would opt for a 30-year amortization and just make increased payments and pre-payments when the sun is shining.

Bill Haywood · Answer

No docks, just four large 16' x 18' doors where you can drive trucks/machinery into. And yes it would be easy to divide into two with a wall. I have over 150k in cash if required. Though I am looking to buy a strip mall in the near future.

Cagney Moreau · Answer

Interesting deal. If the tenant did move out how are the truck docks and offices organized? Can you divide the property with a demising wall?Do you have 60k in cash if the property sits or need a remodel to attract new tenants?

Bill Haywood · Answer

Hi Sam,No independent appraisal done but it wasn't needed. My father owns 5 commercial buildings in the same city and knows the area very well. Also, we are very close to the top commercial real estate broker there so we know comps and what the value is.Regarding the environmental, its a good question. Yes one of the subjects was a stage 1 environmental. No issues came up.I don't want to say exactly where this is but its one of the small town around Edmonton.Thanks

Ram Srinivasan · Answer

@Bill Haywood:Could you share where your building in Alberta is specifically?I personally think it is a pretty good deal (and probably so for both parties). 8 CAP is a number, but did you do an independent appraisal on the property to determine what the CAP Rates are for that particular asset class is in that area?Also, are there any environmental issues/liabilities that you are on the hook for?Because there is only one tenant, I would make sure to network and talk to other companies as well IN case the current tenant leaves. You wouldn't want to start this process after they leave.Yes, increasing the Ammortization rate to me is the right thing to do, because you have a choice as to whether you want to pay down fast or hold for other opportunities.Good work in purchasing this, to me sounds like a good investment.Ram