How do I run numbers on a potential commercial deal?

Question

I have experience with buy and hold residential rentals. However, I have no experience with commercial property or leases. With this said, I recently came across a commercial property that I believe presents a great opportunity. I think this the property would be a prime location for a dollar general, family dollar, a small grocery store, or possibly something else.

My question is, if I do not know what tenant if any would be interested in the property, how do I estimate my all in price? For example, if I know that Dollar General wants to lease the property, I can look at their site requirements and calculate the costs associated with bringing the property up to those standards. Then I can determine what a reasonable purchase price would be and if the property is a good investment. However, if I do not know who the end tenant will be, I do not know how to estimate the costs.

Should I reach out to different companies and talk to them about the site and try to determine its viability and their interest? Is that even something that people do? Is it a good idea or could it result in the company or another investor learning of the property and "stealing" it?

If my question is way off for one reason or another I apologize - again I am learning at this point. Any comments or suggestions are greatly appreciated!

Jeff Kehl · Answer

@Bruce Clark I'm not much more experienced in commercial than you at this point, I bought one commercial property last year and have another small commercial property under contract. So take this with a grain of salt but here are a few things to consider.

A good local commercial broker should be able to help you with some of these questions. My town is small enough where the bigger commercial guys like Marcus and Millichap ignore us but most of the bigger residential realty companies have a broker that specializes in commercial. Look up commercial realty for sale/lease in your area and you'll quickly find them.

What you can determine from them and their listings is how much retail leases for in your area. They seem to always quote it in $/square foot and it's an annual figure so for example  lower end retail in my area goes for about $10/foot.

For the improvement costs (TI, tenant improvements) you can negotiate that with potential tenants but I would again use a short-cut $/square foot or you could do a specific list. Like the one I'm buying needs paved so I estimated that specifically.

For dollar stores specifically, how many are there in a 10 mile diameter of your site? Is there enough population and spendable income close to the site? They will look closely at the demographics.

I've looked at a couple dollar stores but they kind of scare me because there is not much to it, just a big metal building with a concrete floor. Several times I've observed them just move to a lot just down the street and build a new building when their lease was up.

Overall though, I just value commercial the same way I do residential. If the potential rent is good for the purchase price then I just view it as a bit more hard to lease than residential but less hassle/cost once it's leased,

Dion Huey · Answer

Hi Bruce,

1. This sounds like a triple net lease opportunity, so you would not have to pay taxes, insurance and maintenance on the property if you have a quality tenant.

2. I would consider locking up the property for a period while you find a tenant.  This is a great way to mitigate risk if the seller is willing to allow you to lock up the property while you search.

3. When you are analyzing this type of deal, you will want to look at the (a) cash flows that can be produced, (b) the credit (look at the credit metrics on their balance sheet, ie. debt-to-equity ratio, quick ratio, free cash flows) quality of the tenant, (c) scrutinize the guarantor.  More than likely you will get non-investment grade tenants depending on the market you are investing.  For example, you may have a McDonald's lease from you, but more than likely, it would be a franchisee.  Therefore, you will have to scrutinize the credit profile of the franchisee, not McDonald's since it would be the franchisee on the hook should something go wrong.

Good luck!

Bruce Clark · Answer

@Jeff Kehl thanks for the tips. Your suggestions make a lot of sense. I am going to get on the phone with some commercial agents today and get the ball rolling.