Leasing 51% of the building... should I buy it?

Question

I recently signed a lease for my new dental office in a new building. The building is 10,000 sft, and will be completed Spring of 2013.

So far, 85% of the building have been committed to by 4 tenants; my dental office (51% of the building), 3 other national restaurants. The building will be on a very busy artery of the city, with about 60-70,000 vehicles driving through it per day. The 15% of the unoccupied space in the building will likely be leased within a year, because of the very busy location the building is in.

I secured "the right of first refusal" in my lease with the landlord, and feel I should invest in this property within the next couple of years. No price has been agreed at this stage, but the landlord has indicated that the next door building (4,400 sft) which was also recently finished sold for $1,340,000. Suggesting that the building my new office will be in will be at least double that price. I, however, don't agree with that analysis, and would go with what an appraiser thinks of the property. The landlord expects the market CAP rate for the property to be around 7% to 7.5%.

So I discussed this story with my lender, and they told me they would be able to finance this building if I choose to purchase it with 0% down, as long as the seller agrees to sell the building at 85% of the appraised value. In other words, let's say the building is appraised at $2M, I would negotiate it down at 85% of that value ($1.7M), then the bank would finances the $1.7M with 0% down. If seller gets stuck at $1.8M, then I would pickup the $100k difference towards the purchase. Also, the bank would go within their own appraiser in this example, not the seller's.

In any case, the landlord is only building the shell of the building, and all tenants are renovating the interior portions of the space in exchange for a huge discount on the base rent, roughly $4 per sft saving over the first 5 years terms, for my space, the savings is $100k in rent for the first 5 years, plus I negotiated free 5 months of rent when I open my office for business.

The estimated overall income from the building for the first 5 years is about $200k a year, then $250k a year for the next 5 years. All these figures include CAM. Based on my calculation, I think the ROI for this property might be within 8-10 years depending on the final agreed price.

The seller is open to selling the building now while it's still in construction, or down the road when the building is at 100% occupancy (obviously the asking price will be different then). Your thoughts?

Thank you and Happy Thanksgiving!

Adam F · Answer

You didn't background your businsess at all. Are you an existing business or just starting out? How would the building impact your cash flow? What percentage of gross monthly revenue would it chew up? How would vacancies affect you? I own 3 industrial & 1 commercial building for our mfg/dist business. I bought them all in a manner that the combined mortgage cost didn't exceed 15% of my gross revenue per month. This meant paying buildings off early before I aquired more. I always look at the worst case #s and came to the conclusion the anything over 15% put my company in jeoprady of reducing expansion, inventory, employment and my own paycheck. I would do a similiar worst case scenario of your own before signing anything.

Mo Sammy · Answer

Karen, thank you. What did you mean by "the fact that the tenants are financing their own TI's might mean the developer is in too deep, and a deal can be made on the price.". Can you please elaborate more?

Karen Margrave · Answer

Mo Sammy You need more information. First off, what is the sales price going to be? Without that, you can't figure anything. If the other tenants are getting discounted rents in return for their TI's, what is the amount that they are required to spend on TI's for that reduction? How long is the reduced rents in force for? Once that period is over, what will rents be? What is your monthly rental payment? Once you purchase, how much of the mortgage will your rental payment cover? As for the SBA loans, with such low interest rates now, you probably can find a conventional loan that is as competitive. Also, banks LOVE dentists and doctors, and a dentist that is also a minority is probably a bonus. It sounds as though the area in which you are located is a healthy location, therefore; try to get some comps for other properties in the area that are similar and have sold. If you can't find any, you might be able to get them on Loopnet (as paid member) If the property is for sale at market or below, the property is in a good area that is marketable, and the rents on the other units will be market rate in a short time, it probably make sense to invest in your own building, why pay for your landlords investment when you can have it for yourself? Also, the fact that the tenants are financing their own TI's might mean the developer is in too deep, and a deal can be made on the price. Keep us posted.

Mo Sammy · Answer

Thanks everyone. I requested an official offer from the landlord. All previous offers were verbal and guesstimates. Also, I added a 3 years purchase deadline if I accept the offer with my request. At this time, 18% of the 10k building is available for lease with no letter of intent pending. Another 18% has a pending contract with a national chain fast food restaurant. The remaining 64% (including my office) is in contract. Next door building (4,400 sft with 2 national tenants) sold earlier this year for $1.34M at full occupancy. When I get an offer, where is the best place for me start?

Jeremy Cyrier · Answer

Interesting opportunity. Based on the information you've provided, it seems to me that you might capture more upside in this deal by negotiating to buy the building now, because the way the develop is looking at this, he's probably built it on a 9 cap and wants to sell it on a 7 cap, including the rent you're already paying. I'd stop the process now and see if you can get a better deal before he finishes.

Account Closed · Answer

Sounds like you might qualify for an SBA 504 loan on the real estate for the business. Quite likely you could qualify for a 90% loan and may or may not be required to hire new employees. A minority owned business is not subject to some of the additional restrictions. The loan rate is often higher than a conventional loan and often will take longer to complete. You also may be eligible for the SBA 7 equipment loan. Regardless like Adam F suggests you still want to make sure the numbers pencil. I would not confine your due diligence though to the numbers. There are other qualitative issues to consider. Are you planning to stay here long term? Have you considered the stability of these existing tenants and the ability to bring in new tenants? Will you be doing your own property management or hiring all or part of this responsibility out? What is the zoning for the property and how will they impact your choice of tenants? Do you have adequate parking for the types of businesses that you might consider? This only a start, there are many more things to consider.

Bill Gulley · Answer

Joel is right on with a preferred lender, even then it's a slow process. I was thinking you were already under an SBA program from terms sought, I'd say stay conventional if you can. The number of employees I believe is 3, not sure that may change by area by needs, been awhile with SBA, over a year.

Joel Owens · Answer

You will want a "preferred SBA lender". These banks do many SBA loans and can cut through the crud versus someone trying to sell you a pipe dream and has little experience pushing them through. These loans are hard to do and do take a long time with many steps. When the building has national corporate investment grade tenants with guarantees that is viewed as more stable income than mom and pop businesses occupying a building.

Mo Sammy · Answer

Thanks. What is the Number of employees SBA requires to finance this type of deal? And can any bank or lender provide a SBA financing or just some? I hear SBA financing takes long time to close and much more documentations, is it worth it over conventional commercial loans? Thanks again.

Bill Gulley · Answer

Should you buy it? Can't say, I haven't examined the whole deal, but so far so good, sounds like it's a healthy deal to smile about! Complimentary businesses too, people go eat and go next door for teeth cleaning! LOL Really, you're in a unique position as an owner occupied , it's probably a decent deal for you. Depending on how many employees you may have, SBA is an option, may be what the bank is doing. Expect a conservative appraisal! Lucky you, you know the building and the tenants, due diligence is half way done. Good luck!