Go for it or spreading myself too thin?

Question

Hello,

I'm currently considering expanding my commercial investment portfolio.

Here's where I'm at so far:

I bought a 7-office office building for $475k. I'm currently covering all mortgage and operating costs and then some. Currently $353k left on the loan with a bank, should be paid off in ~15 years. My plan is to keep it long term for income in my retirement.

I like this model of purchasing a small office building and holding long term, allowing tenants to pay it off and then it will be income for me when I retire. These are niche tenants in a healthcare field that I know well.

There is another office building I am looking at. Asking price is 390k and it has 4 offices. Operating costs per office are significantly higher than my current building (because it has only 4 offices as opposed to 7), but I have a potential tenant who is interested in leasing out all 4 offices immediately. Assuming I get it for the asking price (though of course I would try negotiating that down a bit), one bank I talked to (who has the loan on my first building) will lend me up to 75% of the sale price, leaving me to cover up to $97,500 + closing costs. I probably have just about that much between the equity in my current home and some savings. The banker said I couldn't take a LOC out on my current office building because they need me to carry at least 25% of the value before they would give me a LOC.

Should I go for it--take out a HELOC on my house to afford the down payment on the second office building, assuming I can get that potential tenant to sign a lease before I make an offer?

Or...is that spreading myself too thin by leveraging too much of my current assets and running the risk that if something goes wrong with the potential tenant, that leaves me in a jam trying to fill an office building with relatively high rent prices?

Thanks for any input!

JG

Ronald Rohde · Answer

How long would it take you to rebuild $100k in savings? if less than 6 months, I'd go for it. If you can get a personal guaranty from a liquid Tenant, I'd go for it.

Ali Hashemi · Answer

My immediate thought is I hope you have a very strong attorney and lease contract. It sounds as though the entire value of the 2nd office building is in the fact that you have a tenant lined up....so locking them into a lease would be the primary constraint.

That being said, why don't they lease from the office building you already own...

Joel Owens · Answer

Not a big fan of office. Not my cup of tea but glad you like it. One tenant for office can be very risky. In last economic downturn these types of businesses tend to go from expansion mode (economy growing) to (contracting mode) economy stagnant or declining. In that situation they tend to look for any cost savings they can get. The cost savings generally are moving to cheaper warehouse space per sq ft, moving business into their basement if possible to save money, initiating a work commute program for employees so they can cut down on cubicle space and go to landlord to reduce building footprint size they lease up.

This is what happened the last downturn as even though not a ton of new office was being built the contraction of existing space by tenants caused a glut in the markets and vacancy levels in some states rose over 20% or more on average. You would need a contingency plan if the larger tenant did not work out ( for example how to cut up the space to smaller tenants if larger tenant reduces or leaves and cost and timeline involved to do it) . Can the potential larger tenant sign a forward commitment on the lease with non-refundable hard earnest money before you buy it?

Adam Johnson · Answer

Personally, I would consider the 2nd building more seriously if you were saying that you had 4 different tenants interested in the building instead of only 1 interested in the whole thing.  Your information is pretty vague (lack of clarity on just how much operating expenses are versus actual income potential), so I am merely making my call based on very limited information.  I don't like it.  You state higher operating costs and only one tenant.  If that tenant leaves, your building is dark very quickly, leaving you holding an empty building with higher operating costs.

Personally, I like the multi-tenant per property model a lot, be it residential or commercial.  It helps spread risk out to some degree.  Using your 7-unit building as the example, if you lost 3 tenants all at once (not very likely, but possible), you could probably limp along until you recovered.  Looking at the 4 unit property with one tenant, if/when something happens to that tenant, you are 100% out of pocket for both debt service as well as operating expenses until you begin to stabilize it.

Frank Procopio · Answer

If you can get them to commit to leasing the new property then go for it

Marco Hagens · Answer

Hi Jon, you are exactly in the position I hope to be in, in about 5 years. I have started with small multi and am looking for other commercial assets.

I'm pretty young. If I were in your position I would take the risk and scrape together everything you can to get the other building and have them both paid down by tenants. Ask to see the financials of your prospective tenant. If it appears they have the means and ability to make your rent payments, you won't be spread thin forever it would only be for the first few years.

It really depends on your risk appetite and how much time you have left until retirement. If you have a few decades left, take the risk. If you are trying to retire sooner than later I would remain risk averse.

David de Luna · Answer

Were it me, yes, pretty thin, but if I get a lease SIGNED PRIOR to close I'd go for it. Even if sometimes a little scary, a chance to win is worth it. But that's just me.