Can u help me put this deal 2gether? $2mil partial owner finance

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Can u help me put this deal 2gether? $2mil partial owner finance

Shane H.
Investor · Wichita, KS · Member since 2015 · 769 posts · 279 votes

Appreciate the help and advice as this topic moves along.  A little long however figure the more info you know the better tailored your advice can be.

What I've got so far.  I met with a local gentleman who started investing in the early 90's.  After meeting with him and expressing his desire for privacy/discretion in sharing information he strikes me as the "millionaire next door" type - lives in a modest neighborhood, drives a modest car, does not want to be flashy, show off his wealth etc.

We've had the chance to meet for 2.5 hours so far.

He's in his 60's best I could tell - ready to retire.  Wants to divest part of his commercial portfolio - his stated goal is to give someone younger an opportunity and he's against selling the properties to one of the few wealthy families/dynasties that control a lot of things around here, does not want to sell through a broker or to someone with great wealth.

He stated he would not prefer to leave the property to his family and is mainly concerned with having an income stream for the next 30 years to carry him through retirement, not worried about living an extravagant lifestyle etc.  Through our conversation I understood he had owned various businesses and may still have some in existence.  Sounded like at one point he had nearly 100 employees working for him - now just has one.

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Property Breakdown - meat and potatoes
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6 Properties total - I'd call it a "C" grade area, an older area of town built up in the 50's and 60's.  All properties are supposed to be close together and  very close to one of the hospitals (we have 3 large ones in town) and all have very easy highway access, and fairly centrally located on main arterials.  It's not a bad area, just not "new & shiny."   Not the poorest of areas, definitely not the wealthiest of areas, the large local grocery chain still maintains grocery stores there, starbucks/wal greens can be found etc.

2 shopping centers, one free standing office building, 3 other mixed use properties that have restaurants, retail and office space.  He is reporting tax value is near 3 million.  He's willing to exit at 2 million, would like 20% down and he would finance the rest so 1.6 mil and he wants a payment of $5555.55 per mo for 30 years which equates to about a 1.65% interest rate.

He may also be willing to partner with a potential buyer -- ie they turn around the properties, and when they are in a better cash position or better able to secure financing for a 20% down payment they buy him out, he may still owner carry the rest at that point as well.

So far I've only only received limited info and have not been able to see the properties as we are just beginning to talk.  He mentioned a non disclosure agreement so would assume we'll need to put one together before being given the line by line details.  I was given the general vicinity and am 99% certain I met him at one of the restaurants included in the package.  I do not have the # of tenants, but he stated to me there is some deferred maintenance, and high vacancy, however he's still cash flowing on all the properties as I was able to see his IRS Schedule E - redacted of course.  States he does not have the desire to focus all of his attention on the properties and wants to move on.  Says someone with new energy should do fine.  He has stated he has been easy going on tenants and some he has not raised the rents in 20 years among other things.

#'s on the IRS Sched E  (rounding for easier math)  (He does not have mortgages on every property - just the 2 shopping centers)
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Prop 1 - Shopping Center 55,000 SF

  • $110500                  Rents (states if full should be appx $264000)
  • $36700                    Earnings after op expenses  before Dep & Mortgage Interest 

------------------------------------------------------------------------

Prop 2 - Office Building - 12,000 SF   (I believe he occupies about 1/3 of it but will move out -- he does not pay rent on this portion of course, uses it as a writeoff)

  • $22200                    Rents (says if you lease space he uses income would be higher)
  • $8075                      Earnings after op expenses before dep &  mortgage interest

-------------------------------------------------------------------------

Prop 3 - Restaurant & Offices   (wasn't given sq footage)

  • $11400                    Rents  (says it should be appx $18k)
  • $2000                      Earnings after op expenses before dep & mortgage interest

 -------------------------------------------------------------------------

Prop 4 - Shopping Center I believe...unk sq footage - didnt get a lot of details on this one

  • $72000                    Rents - unk if it should be higher
  • $24400                    Earnings after op expenses before dep & mortgage interest

--------------------------------------------------------------------------

Prop 5 - Restaurant - unk sq footage - got the impression this bldg was near the end of it's life - said best thing is at some point, scrape and rebuild - this may be a national restaurant and for the most part a NNN lease - made the comment every couple of years they tell him what they will renew the lease for. Not much he does with this one

  • $12800                    Rents 
  • $10400                   Earnings after op expenses & before dep & mortgage interest

----------------------------------------------------------------------------

Prop 6 - Storefront - unk sq footage or if rents are low

  • $22200                    Rents
  • $7600                     Earnings after op expenses & before dept & mortgage interest

**************************************************************

(Based on what he provided me - he earned appx $88k on the 6 properties before taking into account the 2 mortgages he has left and depreciation so unsure of what his exact cash flow was)

I do not know the vacancy percentage at each property - he left the impression it was high, stated one of the large wealthy familes in town who own a lot of retail space have lured some of his former tenants to their properties while he wasn't paying as close attention as he should as they gave signs they were being courted elsewhere, however he missed that.

2 Nationals and lots of mom/pops - no tattoo shops, no vape shops, no check cashing places, no liquor stores.  Only one church - however has been a good long term tenant - reverends family is extremely wealthy and always makes sure the bills are paid.

Is there something here?  I believe there is.  Throwing this out there - anyone with experience in these deals interested in entertaining a partnership?  I'd consider with an experienced individual or will figure out how to do this on my own if this is worth doing.

I've got an email in to him asking for vacancy percentage and # of units at each property.  We plan to meet again soon.

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Christopher Brainard
Rental Property Investor · Rockwall, TX · Member since 2015 · 891 posts · 701 votes
10y

@Shane H.

I'd recommend you proceed with caution. This doesn't seem like much of a deal and that's based on the figures he is giving you, not what you can verify. With a 1.6M Loan, you're looking at mortgage payments somewhere in the $9,000 range, depending on what terms you can negotiate on the seller side. That doesn't include CapEx, maintenance, management, taxes, insurance, etc.

Given that you're looking to borrow the capital for the down payment, I'm not sure how you will manage the instant negative cash flow you inherit.  Additionally, if anything breaks or you have unplanned additional vacancies, I can see this going downhill quick.

To me, this sounds like a deal where the current landlord is inexperienced and/or lazy and is hemorrhaging money and he is looking for someone who isn't savvy to buy his problem for him. This could explain his true reason for not wanting to sell to his wealthy friends.  I realize that I'm far more cynical than your average person, but it helps me get by in business :)

With that being said, there could be upside if what he said was true and you have the knowledge, experience, financial backing, and skills to turn around commercial properties. You will also need to examine your local market and determine what a fair cap rate is for properties of this nature. Given that he currently has ~250k in gross rents and is a Class C Neighborhood, If this were local to me, I would be interested if he halved his asking price. 

-Christopher

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  • Account Closed
    Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
    10y
    Originally posted by @Jonathan Marcus:

    His acquisition Cap is 4.5% but by increasing his NOI, as we both agree the value goes up. But his purchase price remains the same at $2 million. When you apply the new NOI to his price of $2 million, CAP goes up to 6%. Now, if he then decides to sell also at 4.5% Cap based on the increased NOI he gets to pocket $666,667.

    Exactly, he BOUGHT at 4.5% cap rate and SOLD at 4.5% cap rate. The increased in NOI did not change a cap rate, it changed the value. He is pocketing the increase in value NOT the increase in cap rate. There was no $120,000 of NOI when he bought so you cannot use it to calculate a cap rate because it does not exist at the time of purchase.

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  • Jonathan Marcus
    Investor and Commercial Real Estate Agent · New York City, NY · Member since 2013 · 109 posts · 67 votes
    10y

    He doesn't necessarily need to sell the building at 4.5% Cap (same as when he bought it). He can sell at 5 Cap taking a little less profit. He can do so because of the increase in NOI (keeping his purchase price the same) from the improvements he is applying; hence, the increased cap.

    Or if he decides not to sell at all but completes the purchase by exercising his option, the lender would be looking at the newly increased NOI and his purchase price of $2 million and using our example, cap is 6%. The lender would not looking at the old NOI of $90k.

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  • Account Closed
    Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
    10y
    Originally posted by @Jonathan Marcus:

    He doesn't necessarily need to sell the building at 4.5% Cap (same as when he bought it). He can sell at 5 Cap taking a little less profit. He can do so because of the increase in NOI (keeping his purchase price the same) from the improvements he is applying; hence, the increased cap.

    Or if he decides not to sell at all but completes the purchase by exercising his option, the lender would be looking at the newly increased NOI and his purchase price of $2 million and using our example, cap is 6%. The lender would not looking at the old NOI of $90k.

    Jonathon, sure he can sell below market but when the analysis is done on his selling cap rate that fact will be revealed.  Also the lender is not going to be concerned about the cap rate but about the value.  They will use the current market cap rate, 4.5% to value the property.  The analysis will reflect the original option date since that was when there was a meeting of the minds that created the transaction.  The market wants to know this because otherwise it would distort the market cap rate comps and buyers and sellers would think they should be buying and selling at a 6% cap rate.  This is common with commercial transactions where there are delayed closings. 

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  • Joshua Brown
    Lender · Elgin, IL · Member since 2015 · 47 posts · 8 votes
    10y

    I find it hard to believe there is ANY property with a 4.5% cap rate in Wichita.  I would contacts a local appraiser and ask what the average CAPs are for each type of property you are looking at in the specific locals that they are in.

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  • Shane H.
    OP
    Investor · Wichita, KS · Member since 2015 · 769 posts · 279 votes
    10y

    I think I now regret using the word Cap Rate...ha -- it was to give some relevance to what he was asking relative to the NOI he is presently receiving per what I was provided. I think too many folks get caught up in the cap rate business. It's not the end all be all - plenty of other things to consider and only one aspect to look at.

    Interesting thread though.

    1Reply
  • Jonathan Marcus
    Investor and Commercial Real Estate Agent · New York City, NY · Member since 2013 · 109 posts · 67 votes
    10y

    Bob, this in response to your point that increasing rents does not affect cap rates. My contention is that it does. On this particular deal 4.5% is not market cap rate but simply what this particular seller wants to give on this deal, maybe because of the owner financing tied to the deal. And it is not a delayed closing because there is no purchase and sale contract drawn up but rather a lease and an option agreement, which I am sure you know it merely gives the optionee the right-to-buy the asset but not the obligation. 

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  • Account Closed
    Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
    10y
    Originally posted by @Jonathan Marcus:

    Bob, this in response to your point that increasing rents does not affect cap rates. My contention is that it does. On this particular deal 4.5% is not market cap rate but simply what this particular seller wants to give on this deal, maybe because of the owner financing tied to the deal. And it is not a delayed closing because there is no purchase and sale contract drawn up but rather a lease and an option agreement, which I am sure you know it merely gives the optionee the right-to-buy the asset but not the obligation. 

    OK, so Grandma sold below market to her grandson.  Still doesn't change market cap rate. And any analysis of the sale for a cap rate comp will state it was not an open market sale.  And unless the option stated the option would be exercised at the then current market value but rather a value set at the time then yes the meeting of the minds happened at the time of the signing of the option.

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  • Andrey Y.
    Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes
    10y
    Originally posted by @Brent Coombs:

    @Account Closed, your mantra is (and I quote): "Cap rates ARE NOT A PROFIT METRIC!"

    Whereas: unless its cap rate is greater than borrowing costs (ie. significantly greater than 4.5%), there IS no profit from day one! 

    ie. Let Bob and Wes (and other appreciation-gamblers) buy those ones, so it's THEM who have to cough up lots of extra dollars every month for years, until the rents eventually catch up)!

    Brent, so far I was following you. When you said "appreciation gamblers", that shows an uncanny level of naivety. Every person in history that got rich of investments (doesn't matter what type of investment) is then an "appreciation gambler". If thats what you want to call the group, so be it! Hate to break it to you, but a profitable investor is the same thing as an "appreciation gambler" as you call us.

    The only (read again: ONLY) folks who have become rich by investing in midwest cash flow (or is it 'cash faux'?) did it through labor, time, blood, sweat, and tears. Now, does that sound like "investing" to you, or working?

    1Reply
  • Jonathan Marcus
    Investor and Commercial Real Estate Agent · New York City, NY · Member since 2013 · 109 posts · 67 votes
    10y

    Well said @Shane H. Here in NYC I have clients that will buy really low cap deals because they are not after cash flow. They're going after the location then would change the use of the property from say office to mixed-use (retail plus condos) as an example. 

    Anyway, I think I spent too much time on this...good luck in your deals. Listen to your gut, it never stirs your wrong.

    1Reply
  • Brent Coombs
    Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
    10y

    @Andrey Y., when I said "appreciation gamblers", I was keeping in mind these uncertain times we are currently living in. For example, do you want to continue to pay top dollar in our bubble-like economy, when the area you might be looking at has already  been "hot" for longer than usual? Coupled with the fact that you are buying with mostly borrowed money at higher than prime interest rate because you don't have much deposit? And the cash you have to keep putting into it every month is OK, because you have a great job on Wall st?

    My posts are aimed to be helpful to those who don't have the luxury of being already rich...

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  • Andrey Y.
    Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes
    10y
    Originally posted by @Brent Coombs:

    @Andrey Y., when I said "appreciation gamblers", I was keeping in mind these uncertain times we are currently living in. For example, do you want to continue to pay top dollar in our bubble-like economy, when the area you might be looking at has already  been "hot" for longer than usual? Coupled with the fact that you are buying with mostly borrowed money at higher than prime interest rate because you don't have much deposit? And the cash you have to keep putting into it every month is OK, because you have a great job on Wall st?

    My posts are aimed to be helpful to those who don't have the luxury of being already rich...

    Are you serious? Who said anything about "already"?. Most people that made money did so through planning, hard work, and making the right tough choices. I went to school for 13 freaking years, which was by choice. There is no "already rich". I guess, investment bankers were offered a job at the firm as a "luxury"? Or someone was accepted into medical school, again as a "luxury"? These are not accidents mate. Your mindset is very limiting, especially to yourself.

    1Reply
  • Brent Coombs
    Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
    10y

    @Andrey Y., it's one thing to put all your savings and ongoing disposable income into getting into the nice neighborhood that you want to live in, but it's another thing to encourage wannabe newbie average-wage investors (ie. the readers of these posts) into doing the same for their investments.

    Of course I don't know your circumstances, and of course I was exaggerating to make a point. 

    Did you get my point?...

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