Push For More Cash Flow or Get a Great Tenant in Place?

Question

I have a potential tenant interested in leasing a commercial spot that I am currently under contract on. I have met them and can tell based off there lease history and our conversation it would be a great tenant and most likely long term. They would be operating their well established Heating and Air business out of the dwelling I have available and would be adding gravel to the parking level and fixing up the inside slightly on their dime in this deal.

They have offered me $200 below what my initial asking lease price was based off the other comparable places they have found being priced a little lower and includes an outbuilding/warehouse for storage. If I take there deal I will only be cash flowing around $100 a month but my expenses would be covered and I believe I would have a great low maintenance tenant for the long term.

I am seeking some advice from experienced investors on weather they would take this deal and let the tenant pay down the debt and sit and let the property appreciate, I did not mention that this property sits on a major highway and at an intersection of a steadily growing area. Or,  do I push for an extra few hundred in cash flow a month and risk losing out on a long-term tenant? If this happens I will likely be putting in roughly 2K - 5K worth of updates to the property to make it more attractive to tenants and possibly waiting a month or so for another good tenant to come along and hope they pay what I would initially want to price it at.

as i am writing this I am leaning more towards taking their offer. A good tenant can make all the difference and if they are willing to make a few updates to the property on their dollar and my expenses are covered then that cant be bad deal, right?  I also have the opportunity to raise rents over time.

I look forward to your thoughts! thanks.

Jeff Kehl · Answer

@Derek Clark I think that would depend on the market there for similar properties. If it's really hot and you're confident you can quickly rent to another tenant you could wait but if there are a lot of other available commercial spaces I would go ahead and sign with the the prospective tenant.

You could maybe get them to sign a 3 or 5 year lease and build in a yearly 3% rent bump or something like that to make it better.

The fact that you won't have to put any money into the property is really nice as well. Not spending $5k covers the $200 rent discountt for over 2 years.

Paul Smythe · Answer

@Derek Clark I'm not sure I love the thought of purchasing a property to then cashflow $100/month. Are you just looking to park your money somewhere? I'd look at your cash-on-cash return and see if it's really worth it. Also consider what the property will be worth if/when you sell it. Your commercial property will be valued based off of the income it generates. If you're making $1,200 annually then you'll have a harder time selling it for anything worthwhile.

I'm assuming your calculation includes maintenance, but does it include building up reserves for capital expenditures like a new roof? One unexpected issue and your $1,200 profit for the year disappears.

That said, I do like the idea of putting in a long-term, "set it and forget it" type tenant. If you do go with them, I agree with @Jeff Kehl on the 3% annual rental increase. Put it in the lease that the rent increases by 3% each year. That way your cashflow will continue to rise and could be a little more respectable in 3-5 years.

Paul Smythe · Answer

@Derek Clark ahh, that makes a lot more sense. Owner financing changes things. Apologies if I missed that. In that case I think you're on the right track and sounds like you've got a good investment in place.

Derek Clark · Answer

@Paul Smythe You are correct in that I do not own the property currently and will close in the next few weeks. I definitely see your point and would completely agree with buying something else that would generate more cash-flow. Although, I am at the point currently where my debt to income ratio from other financed properties is starting to limit my purchasing power through traditional financing. This deal is owner financed at only 1% higher interest rate than  what I can get on a traditional residential investment loan and amortized over 30yrs with a balloon of 4 yrs. The current owner of this property also has other properties in the area that he is ready to offload in the near future and that may come into play at a later date if this deal happens. I am interested to see how this property appreciates given the new developments that are starting to creep closer. I live in the area and keep up with the trends and road maps as best I can.

@Henri Meli If this is in fact "a long-term, set it and forget it" type tenant then I would do just that and let the property appreciate like I believe it is going to in the near future. I would re-evaluate finding new financing or selling near the end of the 4 yr balloon period with the owner financing.

I have also heard that office tenants sometimes can take longer find. My plan B if that happens is to re-zone back to residential and rent it that way. Surrounding properties are residential and commercial mix so this would work.

Because I have other residential rentals in that area I am confident I can rent it in that way.But this option would require the re-zone and up to 5K worth work on the property. If they do outgrow the space I would come out with a property having some upgrades already paid for by the previous tenants. If they move out then I still have option A ( lease again as commercial) and B (re-zone, make a few upgrades and lease as residential).

They have been in their current leased space for about 8 yrs and would still be there but new management has came in and hiked the prices.

Thanks for your response!

Henri Meli · Answer

@Derek Clark . How long are you planning to keep this building? I really believe that the quality of tenants is very important, especially for office buildings. If your are in this for the long term, I would definitely opt for the best tenant  I can get. Because office buildings don't always fill up fast, I think it would be wise to get this tenant in. I also own an office building and had to make a few compromises recently to keep one of the long term tenants. Think a little bit of yourself as this long time customer of one of those phone companies, that offers massive incentives to lure in new customers, but neglects existing customers.

That said, let me throw another angle at you here. What happens if your tenants outgrows the space you are offering them in a few years? Did you build the leasing contract in such a way that you will have enough time to find a replacement, just in case?

Good luck !!!

Derek Clark · Answer

@Bob Langworthy Appreciate the tip. I will definitely be utilizing the built in lease increase strategy on this property and some of my others.

Paul Smythe · Answer

My understanding of the situation is that @Derek Clark does not yet own the property. Is that correct?

If that is the case, maybe it's not worth buying. I completely understand the value of a stellar tenant, but why put your cash into something that won't give you a return? Why bother? Put it in something that will give you a real return so you can continue generating more cashflow and purchasing more properties.

The appreciation play here can be valuable, so if you really like the area then I can see why you would want to go for it. Just be careful is all I'm saying. It would be rough if you jumped into purchasing an asset where you were essentially breaking even and hoping for the market to help turn it into a good investment.

*Disclaimer that every person has different goals and situations (and there are always a million other different factors to consider), so it's hard to say exactly what you should do. I just don't see the appeal in buying this property from a general investment perspective, especially when you're already considering giving concessions before you've closed on your purchase of the property.

Derek Clark · Answer

@Jeff Kehl & @Paul Smythe

Appreciate your response!

I agree i do not enjoy the idea of $100 cash flow a month and I too was thinking just aquire the tenant and increase rents over time. Losing cash flow in the first 1 or 2 yrs to have good tenants in place is worth it in my mind.

That being said, I do have a nice cushion of cash flow coming in from my other residential rentals along with my wife's and my employment income, fortunately, I'm not really in need of the additional $200 a month and can wait it out . Also,  the money I'm using to purchase this commercial property is from a cash out refi from another rental. So, in a way, I've made myself feel better about the initial $100 in cash flow because of the fact that I'm using the same money I used 4 yrs ago to buy what has the potential to be more valuable in the future and have the ability to raise rents over time.

I do realize the commercial valuation is based from income generation and I plan to one day develop  3-5 townhouses on the back side of the property or something else that would generate additional income.  There is space to build and already a Rd on the side for 2-3 entrances to the property.

Thanks.

Push For More Cash Flow or Get a Great Tenant in Place?

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