Selling my large office/residential zoned house

[Chuck B.]

I've been investing mainly in tough areas to working class neighborhoods, and doing well with it though it requires a lot of eyes on the tenants and properties.

In order to do more deals, my wife and I have agreed to sell our home (currently being used as a duplex), take the equity for working capital and live in a much more modest home while we get some new rentals established.

We originally moved into this place due to the zoning. We were going to do a live/work situation with either my offices or her hair salon on the 1st floor and we'd live in the top two floors. I ended up buying office space with my partner nearby and she moved in with friends at a salon a few streets away, so we changed plans and rented the 3rd floor and took the first two as our residence.

The house is a 125 yr old mansion on the very edge of one of Louisville's more desirable (and pricey) urban neighborhoods. It's zoned uniquely, as only the properties on the busier edge streets are allowed, as OR (office/residential), which allows for a lot of different uses. We're currently using it as a duplex with a separate 3rd floor apartment and my wife and I live on the first two floors. Open a pocket door and some stairwell doors and the house becomes one big place again.

You can see it here: http://www.kcrea.com/jsp/listings/listing_overview.jsp?listingID=8514264

The house has a lot of commercial upgrades, and we've redone most everything else in the ten years since we've been here except for the fully functional, but not very pretty commercial kitchen on the 1st floor and some minor work that needs to be done to the 1st floor's half bath. I'm hesitant to touch that kitchen, as some potential buyers have expressed interest in it (a professional chef thought about using the first floor as a small cooking school and living on the top two floors).

The house has been listed for a year and we recently dropped the price 20K, which has spawned a lot more lookers. However, the majority of offers that we get are to lease the space (both commercially and residential) but no purchase offers yet. We've had a $3K a month commercial lease offer, a $4K a month commercial lease offer (both for non-profit offices) and most recently a $2,500 a month residential lease offer (which we think is a little low).

I'm loathe to rent this place for a couple of reasons... The biggest issue is that I still have a 150K mortgage on it and leasing it wouldn't give us the large, up-front chunk of money to do more deals in small SFRs that I normally work in. The other problem is that it's basically a large antique, we've spent a lot of time and money putting the pieces together with as much integrity as possible and I'm scared of what (especially a commercial) renter would do to the place.

The most recent lease offer (residential for a doctor's family, 2 year lease) at $2,500 prompted my agent to try to do a dual deal, whereby he would sell the house to an investor and simultaneously close the lease to the renter. They're working on this now, so we'll see.

However, if the investor liked this deal at $2,500 a month on lease, he might have loved it at $3K or $4K on lease. Compared to my small house, section 8 rentals, the money doesn't sound so great, but I'm totally outside of my comfort zone when contemplating renting such a large place.

Here's my question... at what sort of monthly lease would this look like a good deal for someone that buys rented properties? (I assume the answer might be wide). And how does the tenant type effect that equation? Are commercial tenants more desirable than residential tenants? In short, I'm wondering if I should have leased it a while ago to a commercial tenant and then listed the property for sale?

As always, any thoughts or advice is much appreciated.

Best,
- Chuck

PS. The 3rd floor, 1BR, currently rents for $700 a month (includes utilities), but hasn't had an increase in seven years. It should probably rent for $900 a month but I can't raise the rents as the most recent tenant wants a year-to-year lease and with trying to sell it, they have to endure showings and the possibility of moving out at any time.

[Jon Holdman]

First, any property that has set on the market for a year is overpriced.

Second, if, after one year, you've dropped the price from $399K to $379K (5%), I think you're not a very motivated seller.

Third, its an unusual property. Its sort of commercial, sort of residential, sort of a fixer to turn it into something someone would actually use.

Fourth, you're emotionally invested in it. You say "it's basically a large antique". No, its just another property.

As far as someone buying this as a rental, the numbers don't look good. I'd want to see something like $6000 a month in rent for this to be interesting at your price. If its really commercial, then a triple net lease at a lower rent might work. That's easy to analyze. Speak with a commercial broker and find out what cap rates are in your area. With a triple net lease, there are very few expenses for the owner - they're all shifted to the tenant. A broker can also help you with typical commercial lease rates. Apply the cap rate and the lease rate to figure out what its worth. This is an easy calculation. If lease rates are, say, $10/sqft/year, and you have 3000 sq.ft, annual rent is $30,000. If common cap rates are 10%, its worth $300K. Thats assuming the lease shifts effectively all the expenses to the tenant. Commercial tenants will typically do what they want with the property, so you have to get past worrying about this if this is where you're headed.

If it could be converted to a SFR, do the typical comps analysis to figure out the value. Do a rent analysis to figure out the rents. If monthly rents are 1% of purchase price, you might get an investor interested as a rental. If they're less than that, it will be tough unless there's some upside.

Maybe it could be converted to several smaller apartments. Is that feasible with zoning? That might net a better price than the other alterantives.