Advice on Small Strip Center Purchase

[Tim Rainey]

Hi,

I am new to the forum and new to real estate other than my office building for my business. I thought it would be wise to have opinions of those more experienced than I am. So, I pasted the basic cash flow from a small strip center that I am looking to purchase below. The property location is on a main street 2 blocks from the only grocery store in a small but fast growing town. The only negatives so far that I see is that parking is not abundant,  but adequate and there is one vacancy which has interest but the current owner has been holding out for something other than a nail salon or supercuts which are both interested. At any rate, it appears that it could be filled quickly. Also, I understand that the rent has not been increased for some time and is past due for that, so there is an upside.

The issue that I am having is that its not much cash flow at the price, which is 2,250,000 with 20% down. At that rate , the monthly debt is 25 year amortization on a 10/1 ARM starting at 5.50% fixed; then adjust every year to 1 year LIBOR ICE SWAP Rate + 3.25% every 5 years with a floor of 5.50%. Estimated payment on this option would be $11,053.57 per month.

So, once the vacancy is filled there should be $2311 in monthly positive cash flow according to fully rented projected NOI. With 1 vacancy there is only $211 cash flow as it stands now which doesnt inspire confidence to me, or am I wrong. The Third set of figures below is projection with vacancy filled.

So, is the return here typical for small strip centers in good locations? Any thoughts on the deal? My CPA is trying to talk me into just sticking cash in the stock market, but I have lost a lot of trust in that. I would really like some NNN real estate and this one looks the best of those that I have found.

Thanks in advance for any advice.

Tim

[Tom Wong]

Hi Tim,

A few general thoughts about this deal:

- Do you already have financing lined up that will allow you to just put 20% down? The reason I ask is that commercial loans for retail centers usually require at least 25%, but probably more like 30-35% down.

- If you buy the property with one space vacant, make sure you account for the leasing commission for the vacant space. Not sure what the typical commission is where you are, but 6% is probably not a bad guess. Also keep in mind that the 6% is for the total value of the lease, so for example if you get a 5-yr lease at $21.00/ft (the seller's quoted $1.75/sf) for a 1,200sf space, you'd be looking at $21.00 x 1,200 x 5 x 0.06 = $7,560.

- On top of the leasing commission, you may also have to provide a tenant improvement allowance, which would vary based on the market and the type of tenant that you want. Alternatively (or perhaps additionally) you may have to provide a free or reduced rent period to entice a new tenant. Factor those into your underwriting.

- Be careful about property tax assessments post-sale. Again, I don't know the particulars of your center, but if it has been held by the same owner for a long time then the property tax assessment could be on the low side. A sale would likely cause that assessment (and thus your property taxes) to go up substantially. Since property tax is a NNN expense, it may not immediately affect your cash flow (it will however increase your tenant's total occupancy costs), but when leases come up for renegotiation, you could get pushback if you try to raise rents.

- You have to have a cash reserve--how much would depend on the age & condition of the building, amount of deferred maintenance, etc. The leases will determine what repair & maintenance items can be charged back to the tenants, but they are also likely set up that you have to front the expense and then bill them back when you do reconciliations, which typically happens once a year. As you probably already know, things like roof repairs can get expensive quick.

- Consider how long is left on the leases that are in place. Also are there any rent bumps already in the leases? Can the seller support how/why the average rent is expected to go up to $25/sf? And if so, why is the seller only assuming that the market rent is $21/sf for the vacant space?

Without knowing anything else, it's hard to say if a stabilized cap rate of 7 is good or bad. I will say, though, that you can definitely find single-tenant net lease deals at your price point that yield at least in the 6s. I have no personal experience with STNL properties, but they are purportedly less work (I wince at the term "mailbox money" but I suppose it's possible) and there are many different national tenants to choose from.

Hope that helps!

Tom