buying a strip mall(6 unit) north of Tampa, FL

General Real Estate Investing
1

First time poster and long time reader of these forums.

I have been looking at buying a small strip mall for a while now and am being honest, I have no prior experiences dealing with strip malls. Appreciate your responses.

I do own a house free of mortgage and will likely use HELOC to fund the down- payment(30%)

The owner is asking about $300K and the strip mall generates a monthly gross income of $4000.

Owner is not flexible with the asking price but is willing to offer owner financing for about 100K so I have to come up with an additional 100K besides the down-payment.

The strip mall is about 60 years old - built in 1960s and had mom&pop stores and everyone of them have signed a 1 year lease. they probably will not consider signing 5 year leases.

The owner collects base rent and then uses it to pay for property taxes, insurance and general maintainence.

Looking at county records, the strip mall is appraised at 600K.

Total Rent - 4K a month = 48K a year
Property Taxes - 13K
Insurance - 6K
Maintenance - 1K

Gross - 18K

Is this a good investment for long term(am not looking to buy and flip)?

What right questions do I need to ask myself before investing?

2

The insurance and taxes are horrendous…! Are these numbers ‘average’ for this type and size of property?

In a normal deal, if you’re doing all the maintenance, as in ‘not’ leasing on a triple net basis (NNN), then figure 50% overhead, including vacancy, but before debt service. That’s $24k available for debt service and cash flow.

HOWEVER, your taxes and insurance are so high, it skews the expenses, in actual percentages, to somewhere around 70% of GSI. This means that your NOI is probably more likely to be $14k (rounded down) which drops the CAP rate to about 4.5%

This then represents a terrible deal, until and unless you can 'significantly raise rents, and/or reduce the insurance and tax overhead. Without one, or more, of these things being improved drastically, there’s no deal here. Well, let’s say you do drop the tax and insurance overhead, you’ve just made the deal average, instead of terrible. And you have no guarantees of reducing the tax or insurance bill after you own the project. So, it’s now a gamble on a terrible property.

Meantime, if the tenant’s ‘are’ triple-net leasing the property (which I completely doubt) then maybe you’ll actually have an NOI in the $24k range, which would push the CAP to 8%. Not a steal, but on a 50 year old building, it’s better than a stick in the eye.

Bottom line, we would not borrow money on our house to buy this. The return is so low, and the upside so remote, it’s a risk of loss too great.

In our mind it’s no wonder the seller is offering partial financing. That’s the only way he can unload this beast at three hundred thousand dollars.

Your negotiating position might include,

“This building does not produce enough income to justify a $300,000 price tag. The taxes are too high and the insurance is too expensive and you have no long term contracts for us to leverage better financing. We believe the projected *NOI on this project to be around fourteen thousand dollars. So, based on the current income, existing expenses, and the existing lease terms, this project is worth *$150,000 to us. When would you like to close?”

*$14k NOI divided by $150k, the CAP is 9.3%. Still not that great, but it’s gonna cash flow. If you put 30% down, or $50k, secured a $100k first at 7% for 20 years, the annual payment would be about $9300, which leaves $4700 a year cash flow, with an annual, cash-on-cash, return of 9.4%. It’s better than a lot of returns. And that doesn’t even account for depreciation and other tax write-offs you receive as the owner.

Oh, by the way, if you lose a tenant, you’re likely to have to finance/pay for the tenant improvements, as an inducement to close on a new tenant, especially if the previous tenant’s use of space was not similar to the new tenant. Just saying.

Hope that provides some useful perspective.

3

Thank you. Very useful!

The taxes and insurance is about right for the size of the property. The strip mall has an additional 3/4 acre vacant land behind the 6-units and this adds to the higher asking price and higher real estate taxes.

The appraisal value and taxes do show up on the county records and for insurance I took the owner’s word.

The tenants will not accept a triple net lease - they will not sign a lease for more than 1 year at a time so there is a possibility of vacancy or additional improvements needed to lure in a new tentant.

I doubt if the owner will accept 150K. I wouldn’t want to insult him with low ball offer but your math seem right to make a case.

4

Of course we’re not wanting to insult the seller, but he’s out of his mind at this price, so what difference does it make if he’s insulted? If he’s insulted, he’s not going to sell to us at a reasonable price anyway, so who cares?

If he’s not insulted, and drops his price to something reasonable, like $150,000, then we’ve won, the seller won, and everybody is happy. But failing to make an offer, for fear of insulting the seller, is an amateur’s approach.

Now there’s “insulting the seller” and then there’s “insulting the seller’s price.” It’s perfectly fine to abuse the seller’s price. Just don’t abuse the seller.

That said, insulting anyone, or his position. isn’t really that elegant or professional. So, we like to come in soft, and then keep drilling to the depth we need to make a profitable deal. One of those approaches is simply outlining the numbers as suggested in the previous post. What’s really powerful is using the seller’s numbers against him.

For example a seller will quote us a cap rate of 11%. “Yippee” we say. Then we analyze the numbers and it comes to a 4.5% CAP. Whoops. So we go over the actual numbers with the seller (that he has provided) and then add the rest of the normal expenses he has failed to account for, and all of the sudden, the seller figures out that we know his numbers better than he does, and he can’t argue with them, because we started with his own numbers.

The numbers we analyze with the seller shows the actual cap rate to be 4.5%, not 11%.

At that point, we might say,

“Mr. Seller, you told us this building offered me an 11% CAP, and that’s the minimum CAP we will buy at for cash. In order for us to achieve the CAP rate you advertised, and for us to remain interested in buying this property, we need a price based on that 11% CAP, which means the purchase price needs to be One hundred and fifty thousand, not Three hundred thousand. If you’ll sell to us for a reasonable price, we’re prepared to close as soon as possible. If not, then we’ll keep looking for a reasonably priced project.”

What have we actually said?

  1. We’ve told the seller that he misrepresented his CAP rate…
  2. That his property is overpriced at that CAP rate…
  3. We need to buy at the advertised CAP rate…
  4. That we only want to buy at a reasonable price
  5. And that we’ll move on to a reasonably priced investing, if he doesn’t agree to a reasonable price of $150,000 which reflects that CAP rate he advertised.

An alternate gambit might be to make a back-up offer to the seller, based on our target CAP rate.

Couched this way, we might say,

"Mr. Seller, we’re too far away from your price of $300,000. The current income just doesn’t give us enough to be interested. However, we do like your property if we can buy it for a reasonable price.

In the meantime, we would like to make a back up offer to you.

Would you be open to that, or not? [Seller puts his palm to his chin thinking about what’s coming down the pike here, and asks, “What’s that mean?”]

This just means that we will make you a standing offer for six months, that gives you that much time to find a full price buyer. Meantime, we’re remain ready, willing and able to close if you change your mind during that time, but if you find a full price buyer, you just give us $5,000 to walk away and cancel our contract with you.

With our offer you’ve always got a buyer ready; us, or somebody willing to pay your price.

How’s that sound?"

Anything can happen after this. However, there is a significant chance that the seller, will dwell on our offer price, and start figuring out how he can accept it.

Meantime, we’ve mentally locked in this figure in the seller’s head, and he can’t help, but mull it over in the next few days, or even weeks. That’s just human nature.

Next thing we know he’s calling us and saying, “I’ll sell my building to you for $150,000, but you’ve got to pay all the closing costs.” Here he’s asking for a minor trade-off. That’s OK. It’s a matter of agreeing to those terms and acting quickly. We got your price, the seller got his sale/equity.

Anyway, we’re not afraid of insulting the seller’s asking prices. We simply frame your offers in such a way that they seem “reasonable.”

Speaking of Barney Zick …he used to teach us to add a “because” to every request during our negotiations. For example, “We need the price to be “x” because…” Or we need all the furniture in the building included in the sale price, because… (fill in the blank).

The ‘because’ didn’t need to be that compelling or persuasive, but it needed to be there. Sellers (or any prospects) need to ‘know’ there’s a reason behind our requests to “equity strip them blind,” or the request will come off as ‘empty’ and easily dismissible.

In this case, we’re telling the seller,

“We need the price to be $150,000, because that’s the only sensible price, considering the current income and expenses, and in order to achieve the 11% CAP you said this property offered …which is our minimum acceptable rate for projects like this.”

We could probably say this more elegantly, but that’s the gist.

Hope that helps.

5

Thank you. Am convinced that staying near the CAP rate of 10% would provide me the safety net that’s required.

Regarding appraisal(its going to cost me 2k-3k), Would it make sense to ‘offer’ more if the appraisal come in at a higher price? or should I stick to the current income potential?

6

You don’t want to pay for an appraisal unless you have the project under contract, and the bank’s willing to finance the project, contingent upon a satisfactory appraisal.

If the appraisal comes in lower than the contract price, you can renegotiate the price/terms using that underwater appraisal. However, if the appraisal comes in higher, the seller may try to back out of your deal.

I've had sellers try to back out of deals because the appraised value was much more than what my contract price was. One seller offered me several thousand dollars not to buy. How'd that happen you might ask.

I knew I was buying at a steal price, so I recorded a Memorandum of Agreement to protect myself from the seller’s likely temptation to shop my offer. The seller did shop my offer. Hmmm.

And the seller unceremoniously informed me that he was not going to sell to me. I knew why without him saying. I said, “Fine.” Then I explained …to the seller… that I had an enforceable purchase agreement, and that I had recorded a memorandum on the property, so that if he wasn’t willing to sell to me, he wasn’t going to sell that property until his great grandchildren were dead (I know; classy).

As the steam from his brain was practically blowing his ears out, he offered me several thousand dollars to give up my position.

Back at the ranch. The problem is that appraisals can reflect things that have little to do with the actual value of your building (or the value we place on the property).

For example the replacement value of a project will be part of the appraisal, and might represent $2M. That appraisal figure does not make that building worth $2M.

It’s all about YOUR valuation, based on the current/potential operating numbers. At the same time, a pro forma might show significantly better numbers, and consequently show a much higher potential value.

And potential values are notoriously popular justifications for sellers to ask for the moon.

Meantime again, whatever equity upside there is, we’re not interested in giving any of that to the seller. Instead, of course, we focus on giving the seller as little of the current equity as possible.

Anyway, the financing appraisal is for banks, not us. Later when we want to sell, or refinance, the appraisal all of the sudden becomes important to both the bank AND to us.

Meantime, we wait until the bank says they’ll fund the loan, contingent on an adequate appraisal. That’s the safe way to go forward.

7

Just want to update this thread…

The owner has sold the strip mall for $230K…My offer was below $200K. I don’t know much about the buyer but probably his/her math worked in their favour.

8

Tampaite,

Thank you for the update.
I believe you are lucky not getting this as your first rental property.
If you have no experience in retail/strip malls you are better off learning on someone else’s dime.
With residential real estate, there is always a market for your product.
There are thousands of resources to assist you with residential real estate.

If you are commited to the commercial retail/ strip center model, I would encourgage you to seek out someone who is successfull at it and have them teach you their methodology. Commercial is not nearly as forgiving of mistakes as residential is.
I would get educated before I jumped into a “deal” for $200k.

pete

9

I have noticed that rich people invest in commercial real estate (strip centers, office buildings and the like). I have never found a rich person that is investing in these commercial properties that got rich investing in them. When I ask them how they made their money none of them said by investing in commercial properties.