Commercial Due Diligence...what am I missing?

Question

BP community,

Background:

A few things to note before I get into this thing. I have been quiet on the forums, but have listened to most podcast episodes, I belong to meetups etc...I live in an up-and-coming, somewhat urban, Cincinnati neighborhood of about 30,000 residence. We have made some solid connections here and have invested in this area only as our vision is to have a positive impact on the community here through real estate. On this journey, my wife has become a real estate agent and has focused her attention on the area as well.

Situation:

A few months ago, I cold-called the local head of city council because I found out he owned a commercial building nearby (which piqued my interest) and we met for a beer, chatted about the possibilities and then things went radio silent. Earlier this week, he texted me asking if I was still interested and we met at the property to walk through. We got to talking and because of his insight on city council, he knows of several other developments slated for the next year or so which will ideally take our town from "up-and-coming" to "the cool part of town". Why does he want to sell?? He now has 5 kids, a full time job and other investments. He seems to care more about who the property goes to, ensuring that the buyer has the same aspirations for the development of the town, as opposed to price.

My plan is to buy & hold, fix it up because it's a wreck and rent to tenants who want to have the best interest of our town in mind.

Question:

This has been long-winded, I know. But I felt it important to lay ALL of this out because its a little cumbersome.

My question for you all is:

What questions should I be asking at this point? We have only walked the property once and texted a couple times. He knows I am interested but that's all.

What are some good resources when it comes to due diligence in this area? I don't want to buy it and get burned with something I have never heard of.

What am I missing?

Thanks for any feedback!

Joel Owens · Answer

500-700 sf is really small. Most spaces under 900 sq ft are hard to rent to good retail tenant types.

Likely combine the 2 spaces for 1,000 to 1,400 sq ft so that you open yourself up to more tenants and their footprint models.

Justin Frank · Answer

@Ryan Slicer

If the building is a wreck and you don’t know the basics of what to do for due diligence for a commercial retail property I would be weary of going into this alone. Maybe you can find a mentor with some commercial experience to help you out? Retail spaces can be great but they also fail much more than any other REI. If you are to move forward I would take @Scott McElhaney advice and try to get these buildings leased up before you close. I work with a commercial developer who does this all the time. If you have difficulty finding interest during your study period you may want to walk away. If you have high interest and due diligence goes well then you may be into something good. Also, you need to consider that a lender may not want to loan against this building if it is sitting vacant. That, and a some of your best retail tenants will want the building owner to pay for all TIs prior to them moving into the buildings. You can reabsorb these costs in your lease but you may have to fund the TIs up front. The last commercial building I looked at was a $1.6mm purchase. During due diligence we were able to get a LOI from a national company at $15k/mo and NNN. Part of the LOI was that we would fund the $150k of TI to the building prior to the tenant moving in. We had planned on writing the TI costs back into the lease and the deal was a home run until the city decided they did not want this particular business in the spot we were purchasing. Hopefully I didn’t blab on too much, and hopefully I answered at least one of your questions. If you need anymore help, please ask. Let us know what you decide

Scott McElhaney · Answer

Ryan, I've purchased many retail buildings vacant, many in excellent locations.  If you can swing it I would negotiate a right during the study period to be able to market the spaces for lease.  I've done this several times and have been fortunate to sometimes sign an LOI and even a lease contingent upon our ultimate purchase of the property before closing.  However, the goal is really to "test" the market and see how desirable the spaces are in that given market AND if the rents you need to obtain correlate with the negotiated purchase price. You also want to gather feedback from prospective tenants and/or their brokers on their impressions of the building and the spaces....do they think they're appealing, what do they like and what do they not like?  I will caution you that retail is a great asset class, it's my personal favorite.  However, they can take awhile to lease up AND the Landlord concessions, such as free rent and Tenant Improvement allowance can eat into your numbers quickly.  When in doubt run your proformas conservatively.

Ronald Rohde · Answer

Makes sense, especially with storage, bathrooms, etc. Ohio is probably similar to Texas in that regard.

Ryan Slicer · Answer

Thanks for the responses...this is a mixed use commercial building in downtown Westwood (which I know very well). It is currently 2 storefronts and completely unoccupied. The current owner purchased the property with the intention of opening a little health food store but never got around to it. I don't have exact specs but it looks to me like each side is approx. 500-700 SF.

The initiative to restore Westwood began in 2010 and is just now finally catching fire. Several businesses have invested and things are happening weekly, it seems.

This looks to be a great opportunity to get in on the ground floor of something big and ride it to the top. However, I know that I am emotional about this deal because its in my own town and I want to see these storefronts fill up with great owners/tenants. I'm doing my best to look at this objectively as strictly business and that's the reason I'm reaching out on the forum. I need other investors to clue me into the best practices used in making a good/profitable decision.

Heshel Mangel · Answer

@Ryan Slicer What area is this if I may ask? How large is the property in size and units? When you walked the property - what did you find? You will want to see the financials of the property - current and historical. You will want to know the basic components of the property, especially the big ticket items - roof, foundation, exterior, electrical, piping. Can this are attract the type of tenants you want, for the price you think? What would it take to get it there - look at comparable properties.

Hope that helps. Feel free to connect and send a message if I can be of any value.

Jeff Stein · Answer

What kind of building is it? Apartment? Mixed use?

Is it currently occupied? I would ask about a rent roll.

Do you know the area well? Has the neighborhood already started to turn over and improve or is this something the city council is hoping will happen over the next 5-10 years.

I would then run my numbers based on the current neighborhood and see if it would work at different price points.

Commercial Due Diligence...what am I missing?

Most Popular Reply