Should I still close on this commercial property

Question

I recently got an offer accepted to buy a 13,000 sq ft commercial building in a good area downtown.

I have a tenant in place.

The property is a value add property that i will rehab for the tenant. My plan is to refinance it after rehabbing and stabilizing-the property. The tenant wants to turn the property into an event space, beer garden, and food hall business.

My concern/question is, with all this corona virus, do you think the prices of commercial real estate will go down significantly? Will the cap rates rise in a couple of months?

Should I back away from the deal?

Im a fairly new investor and this is my first retail commercial deal ...any input would help!

Jacob Dawson · Answer

Hello Nicole, I am a commercial real estate broker from Chicago, specializing in retail and NNN investments.

The things that I would ask myself would be:

1.  Who is backing the lease? (is the lease payment backed by a large company? Does the owner of the event space back it?)

2.  What is the likelihood that the tenant will be profitable? How long will it be until they ARE profitable? No one will be using event space for the next few months.

3. Filling a 13,000 SF space is a hard thing to do. Even in a city. You have to ask yourself if the tenant leaves and can NOT pay rent. How likely is it that I can refill the space.

4. If the tenant vacates the area, can you subdivide the space into smaller units?

I love the BRRRR strategy applied to retail. I believe it is better than doing it with multi-families. But you need to look at the strength of the tenant. But with this deal, you need to weigh the risk of not having a paying tenant long term for your refi down the line.

If you want to have a more extended discussion on this subject, I would be happy to have that. Otherwise, good luck!

Nicole Pinedo · Answer

@Doran Summers I’ve been talking to Visio Lending. I’m pretty sure they still are

Douglas Mcqueen · Answer

Commercial values are largely determined by the income the building produces, if you are buying based on the building being empty or generating no or little income then the value shouldn't decrease much at all.  With the value add strategy you should be in an even better position as i would assume you are coming in well below market value.

You may want to look at the prospect of income in the near future as event space in this climate will not be making much in the next few months and therefore may or may not be able to cover the rent, however if you use this time to complete the rehab i would think you are in a pretty good position.

It all comes down to making sure the deal is a good one, now more then ever.  The deal needs to be able to stand on its own, and not contingent on everything going right in the rehab, rehabs will always have problems (over time/over budget)  You make your money when you buy so make sure you are buying smart.

Jacob Dawson · Answer

@Nicole Pinedo yeah no problem! With a 15 year term, you should be golden!

One question though, why go through that entire process when you could just sell the property. If you sold the property after the build-out was complete, you could still gain the same amount of money from the deal (1.8m - expenses)  with much less risk. Plus, you could take the proceeds and use them as a down payment for a 1031 exchange deal(s)

Nicole Pinedo · Answer

@Jacob Dawson Got it! The price for the building is 235k. Lease is 15 years. We would pay for roof and structure. I’m actually replacing the roof once i close on the property.

I was thinking of refinancing quickly in 1-3 months with a hard money lender that’s offering me. 6% interest, then wait a a little more (like a year or so) to refinance through a bank with a lower %. that would get me out of the original loan faster and have reserves, could also reinvest some of it into some flips to keep paying off the new refinance loan.

But thank you so much for your advice, it was helpful!

Jacob Dawson · Answer

@Nicole Pinedo

To start, I think it's good that they did a corporate-backed lease.

I have a few questions, though.

1.  Was the price for the property 235,000, or was that the down payment?

2. How long is the lease for?

3. As the landlord, what are you responsible for? I.E., Roof and structure, etc

I ask these things because, with STNL properties (single tenant net lease), things get a bit tricky when you go for a refinance/ to sell. Let's say they signed a ten-year lease. The building is producing money, and everything is okay. But after five years of good cashflows, you refinance. The bank will look at a single tenant net lease property with five years left (not the best sign) because the bank does not know if the tenant will renew the lease. A way around this is to write in the lease that the store must provide monthly sales figures. If the store sales are good, then you will have a much easier time selling the asset or refinancing it. You have a good deal here I would recommend refinancing as soon as you can and try to get the tenant to report their sales.

Overall I would say you did a great job on this deal!! Just try to get the sales figures written in the lease. If you have any more questions, I would be happy to help.

Nicole Pinedo · Answer

@Scott McElhaney it’s a triple N lease and the tenant is paying for the entire buildout. They’re also in the hospitality industry with a lot of experience.

My concern is more of the market and if i could still refinance and be ok. Another possible concern is if cyber quarantine period lasts years and not months. But i guess I should just wait and see what’s going to happen.

Thank you soo much for your help!! I appreciate it

Nicole Pinedo · Answer

@Jacob Dawson @Jacob Dawson Hey Jacob, thank you so much for your response.

Yes, the event space business would back the lease. They have a lot of experience in the hospitality space.

I guess my concern would be, are people going to be allowed to go out anymore, and would this affect their income. Also when I refinance, would the property appraise for way less because the commercial real estate market cap rates would rise?

I’m sort of torn but waiting to see what happens with the market.

I’m buying the property for 235k, it’s a really great deal for the space for the amount of land and area. With the lease in place the arv based on income/cap rate comes at 1.8 mil. But based on that, even if the market drops 25% i think i still would do pretty well.

What are your thoughts?

Jacob Dawson · Answer

Hello Nicole, are there any new updates on the property you are closing on?

Scott McElhaney · Answer

Nicole,

Can you elaborate on the deal you've carved out with the existing tenant?  Are you providing a Tenant Improvement (TI) allowance to the tenant?  OR have you agreed as the Landlord to renovate the space into an event space/beer garden for the existing tenant?  Lastly, what is the existing tenant's current business?  Is it hospitality/restaurant based?  Do they have a good track record in this line of work?

You always need to weigh the economical strength of the tenant versus the tenant specific improvements/build-out that you're considering spending cash on.  In other words, if the tenant is weak financially, weak in experience (for this given business focus) and/or weak in both... you need to strongly consider the "what if tenant doesn't make it" scenario.  The last thing you want to do is spend a bunch of money of a very tenant specific build-out, have them go out of business and then have to re-lease to a new tenant who will most likely rip out everything related to the last tenant's business concept.  Make sense?

Should I still close on this commercial property

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