DSCR is the debt servicing ratio which is basically the NOI (net operating Income - expenses. It should be at least 1.15 for you to be operating in a positive cash flow with some reserves. 1.25 is a decent profit margin.
Yes, FICO
Investing experience. Property management exp, is also helpful.
The rent roll and occupancy rate is important as well.
80% is fine, and some seller financing is fine, however, on loans of this size, some of your own cash is going to have to go into it as well. Perhaps as much or litle as 5%/ Cross collateralization is also an acceptable form of down payment.
Yes, lack of experience is a derog but not as much an issue with apt. bldgs since there will probably be a management company involved.
Just some input in the potential of commercial investment. And, I like Jeff’s reaction early in the chain about it not being scary. I do not believe it is any scarier than any other investment. You need to learn about it, understand it, and capitalize on it. Even though a lot of investors making the move from residential investment to commercial will focus on apartments and residential use, the potential for small commerical use might be just as strong or greater.
With the sudden boom in residential housing over the last few years, many markets have seen a lot of their commercial properties converted to residential. There are places in our area, like shore areas, where the community has lost a lot of its commercial enterprise as new condos and townhomes have gone up. We have seen lots of subdivisions pop up in urban areas. This has left a big gap in these areas between a growing consumer base and the available commercial entities to service it. Many times you will see these communities get very tough with their zoning ordinances and variances in an attempt to save their commercial operations. Often when an area is reaching the heigth of its residential development, the potential for small commerical development to service the area can be huge. Often, in many urban areas, you will see Reinvestment, Redevelopment and Enterpise zones designated. The process of urban redevelopment is usually first hinged on homeownership intiatives. It is usually then focused on small business and commercial development to service the area and provide jobs and economic base. Often the greatest potential for an investor may not be with the homeownership initiative but in the business and commercial redevelopment side of the equation.
I am sure we have all seen the boom in new construction sub-divisions. We have areas in our region that have simply replaced vast rural farming areas with incredible numbers of housing units. And, it still continues in these areas and the homes are getting sold. When this type of new construction booms in rural areas, there always seems to be a big gap in the available commercial to support it. Before you know it, the back country road that led to the forests and the favorite apple farm slowly becomes lined with new commercial entities. Economics of this cycle seem to dictate the consumer comes first, the commodity and service second.
So, when you are finding it hard to pull off a residential project because your market seems to have flattened out, try looking at small commercial projects. It just might open a new realm of possiblities that have been neglected in your market.
I couldnt agree more. In addition to apartment complexes I am looking for long term commercial monthly income and like the idea of triple NNN leases. Its relatively easy to find HML and private money for residential properties but are there similar resources for triple NNNs? My favorite site for locating the businesses is Loopnet.
Thanks for all of the information. I apologize for the time lag. Jeff, the papers did not come back to my liking so I backed out of the deal. I will keep you in mind should other properties come up. I especially like the $150,000 line of credit that could be available. As far as doing the earlier question of what types of paper I gather during due diligence, I ask for a copy of all the leases for study, financial records: P & L’s for past 3-5 years, balance sheets, rent roll; tax returns x 3 years; insurance policy; existing loan documents: notes, deeds of trust, closing statements, title policy, rate riders, contact name and numbers, etc.; deed; all leases; service or advertising contracts; appraisals, engineering reports, environmental reports; survey report; payroll register: list of employees with position, wage rate, and entitled benefits; business license; physical inventory of furniture, fixtures, equipment, and supplies; utility bills; bank statements showing deposits; phone system documents; computer systems; fire system inspection reports; litigation history.
Whew,
Your certainly do your share of due diligence.
Keeps you from getting burned.
Now if everyone would just make a note of what you said, they
can save themselves a lot of headaches.
It’s the little tidbits that people like you post here that they couldn’t pay someone to teach them.
Sorry your deal fell through. If it was meant to be it would have been. One door closes and another one opens.
Thanks for the very useful info. What is HML?
Also, I just started a C-corp and I am looking to purchase land, possibly for a mobile home park. What is the best way to finance this venture with little to no out of pocket expenses? I’m not clear on a price range yet poss. 500k for land and development.
I have a deal that I’d really appreciate some input on. This is a commercial space that has a 5 year lease attached to it – a daycare center. The lease brings in about $47.000 per year in rent. Tennant pays all other costs, which is one of the good thigs about commercial.
Purchase prince $500,000.
Let’s say I don’t want to use my own money. But I have a home equity line of credit. $4000,000 morgage at 7%. Plus 20% down $100,000 on my home equity line. That means that in the first four years I have a negative flow totaling $20,000. But of course I put nothing down.
But let’s say I kick in $20,000 upfront – THEN at the end of five years I break even! – so what did the deal do for me – hear I am all excited about the fact that there is a nice 5 year tennent attached to this thing. But the lease doesn’t bring me any flow unless I kick in a whole bunch of cash – .
And at the end of five years, what if he does not re-sign? It might be hard to find someone else who wants to operate a daycare center. If he does resign, it could be profitable – but I would have to make no money for FIVE years in order to find that out.
Is this a good investment? What would make it a good investment?
How much do you have in reserve for unforseen incidentals? Is the building in good shape? Whose responsible for the maintenance of the building? I am no expert but these are things I have learned you need to be aware of. If you had cashflow then you could kind of rely on that I suppose.
Ideally, if you put money into a deal you want to get it back at closing or by refinancing asap.
The building is in good shape and there is this nice 5 year renter – trouble is I can’t figure out how I make money. I break even. By the time I might cashflow, the lease is over – I’ve got to pray he re-signs.
What attracted you to the deal other than “the fact that there is a nice 5 year tennent attached to this thing” ?
What happens if the tenant business terminates before the end of the term? Its great that you are getting into commercial leasing but again, you want those deals where there are multiple tenants to help offset vacancies and ideally, a guarantee that the lease payments will be paid to term. I dont see how you could make this work to your financial benefit. Perhaps someone else has other ideas.
On a positive note, daycare is a sure thing in my area and something I would consider because of the demand. Hopefully its the same in yours and my wish for you is that the tenant will prosper and extend the lease.
Give me your email so we could keep in touch. I’d like to feed off your experience.
For those who own commercial property, there is a rather new tax strategy called Cost Segregation Analysis or Building Component Analysis. The IRS requires an engineering approach to determine the benefits for a cost segregation study. You probably have not heard of this because most CPA firms do not have an engineering department or understand the complexities of breaking down a buildings components within a commercial property. Fortune 500 companies have used this analysis for years, but because of recent court cases the small commercial property investor can take advantage of these new court cases. In short, most commercial property owners depreciate their building using the straight line method of 39 years. A building component analysis re-classifies the components in the building to shorter depreciation lives of 5, 7 & 15 years, which accelerates the depreciation and increases cash flow for other products.
Another benefit for owners of commercial property is that if you have owned the building for, as an example, 7 years, the IRS allows you to catch up on your depreciation from those past 7 years and apply all of that catch up in the year you change your accounting method. The majority of commercial property owners can see a minimum of hundreds of thousands of dollars in tax benefits by using this analysis.
If you have any questions regarding this new tax strategy, please do not hesitate to ask questions and I will do my best to answer them. If you are an active investor or own a commercial property, you can definitely benefit from a cost segregation analysis.
I appreciate your answers, you offer very good advice.