I’ve been on the residential side for several years now and would like to get into commerical side but I’m baffeled by how can one make money in the commercial world. I see so many commercial spaces sit vacant for months on end. Please somebody tell me what sort of numbers do commerical properties run to justify them sitting empty. How do you people make a profit? Here’s an example:
I am insterested in a 5500 sq ft Doctor’s office selling at $665,000? Let say somebody buys it at $550,000 (not likely). With good credit you’ll get a loan for 20 years at 1+prime. Today’s prime is at 8.25. Putting %20 down, with tax and insurance I figure my monthly expenses to be around $5000 (not including any other maintenace costs). Around here (Oklahoma) rent goes for around 10-12/sq ft. And that’s comes to exactly about $5000 month. So some one please tell me: Where is the money in commercial world? What am I missing?
Thanks!
I assume on that particular deal the $10-12/ sq ft is on an annual basis. That property it probably meant for the doctor to own the office, not rent from an investor, i.e.- a retail deal. The money in the commercial world will not be found there.
It’s the same as residential, not every property is a winner. Most of the vacant properties you see will sit vacant until the inflexible owner lowers the price or the market catches up. Just keep looking, you’ll find one eventually. Most of the time the owners of commercial properties are a bit more savvy than a typical homeowner so getting a property for a steal is not as common in commercial.
When your talking about retail deals, class A buildings, etc. the purchasers are usually those with a LOT of cash to put down and only require a modest return. You’ll have to figure out a creative niche to make any serious returns.
So what sort of portfolio a typical individual owning commercial properties may own (notice I said individual not major corps)? What sort of return would you look for? An example would be great. Last but not least would you mind expanding on your last comment: “You’ll have to figure out a creative niche to make any serious returns.”
My thing is rehabs. I started in residential doing rehabs- retail. Now I do commercial rehabs- rentals as well. My niche within commercial is to turn small industrial properties into something more useful. Althought I do own other buildings, this is my favorite thing to do. More and more manufacturing is done overseas or in very large facilties. Big box stores are such a big outlet for both retail and wholesale goods, that small companies go out of business, thus don’t use small warehouses. Big box stores store there products in huge distribution facilities. Therefore, in older parts of the country, where manufacturing and storage used to be, there are a lot of small old industrial buildings laying vacant.
Example #1
Turning vacant warehouses/ factories into office space. This entails a large scale rehab after I get the zoning changed. The offices are always high end loft style places that are very cool looking inside. Hopefully if there was a freight elevator, I can keep it intact to keep the upscale-industrial-urban theme.
Example #2
I just bought a vacant 1 story warehouse across from a small municipal airport. The building has thousands of small windows facing the runway. What I plan to do with this is to rip the glass front out and replace them with large sliding doors to turn the place into a hangar. Luxury homes are being built all over this town and growth is strong so more people with small planes are going to need a safe, secure place to park them. It will have room for 20-22 small planes.
The downside is that this building is across a street from the runway. It’s not a main heavily traveled street by rather one that leads to a airport hotel/ restaurant and the police aviation division office/ hangar (may be better to call it a 2 lane driveway). What I’m doing now is getting bids from contractors to reroute the road on the backside of this building with the cities permission, so that plane traffic and automobile traffic aren’t intersecting. I will be “donating” the land for the road that is now part of my parking lot, but it needs to be resurfaced because of the 50 year old pot holes/ tank traps.
My 4 major expenses are building a small road for the city, resurfacing the “parking lot” on the runway side so we don’t lose any planes in the pot holes, putting in some divider walls and buying or making big sliding doors. The building is a big brick box with no structural supports interfering on the floor space so where one unit starts and stops is totally up to me. This building will be nothing but bricks, concrete, steel and aluminum, will need little to no maintenance after a few doors, and I will have turned a completely useless building into something producing a decent income.
First off, I believe there are better rates out there than prime +1 in fact, I know there is. Second, I would never get an ammortizing mortgage on an investment property. There is no need to pay back principal if you are going to hold it for cash flow. You also get a better cash on cash return. Another is the leverage ratio. 80% LTV may not maximize your return, you may have to move to 70% LTV or may be down to 50% LTV for that property. When I worked for a large REIT all their properties were leveraged between 50-60%. you have to find the g-spot for the property. Back to ammortization, just buy using an interest only product you increase your cash flow by almost a grand.
Thanks for taking the time and telling me about your projects. Project #2 is especially interesting. Now I know what you mean about finding a niche. I know zonning change could be difficult and time consuming but I catch your drift.
Sean,
Could you give me a bit more info on the terms of “less than prime” or interest only loans? May be a link. I thought if you had good credit the best you could do was prime+1.
Let me give a little more detail. If your dealing with a mortgage of under $500,000 you may not find a better rate than 8.25%. If dealing with a mortgage greater that $500,000 there are better rates. I have worked alot with LaSalle Bank. I would recommend speaking with them.
Second, I would never get an ammortizing mortgage on an investment property. There is no need to pay back principal if you are going to hold it for cash flow.
Sean,
I completely disagree with that idea. I would NEVER do an interest only loan and in fact, all of my loans amortize over 20 years (which is fairly standard for commercial). I want the principal paid down, so that my equity and my options are always increasing. If I allow the loans to be paid off, my cash flow (profit) more than doubles and I also have the option of selling and cashing out.
Property appreciation (with an I/O loan) or value appreciation (by way of principal repayment)…IMHO, both strategies have there place (at the right time/market), but in a potentially declining market, it is safest to pay down principal.
prop value: $125,000
mort: $100,000
ammort: 20 yr
LTV: 80%
Int: 8%
Amort Pmt: $836.44
Int only Pmt: $666.66
Equity Build from ammortization: @ yr 5 $12,474.41
Diff in pmt for int only: $169.78 per month or $2,037 per year
Diff discounted monthly at safe rate of 4.5% (5 yr treasury): $9,106.89
Equity discounted yearly at safe rate: $10,010.10
In this example you made $903.20 more in equity over a 5 year period above what you saved on your mortgage pmt. You also did not have the ability to use those funds for other investment over the period. This example also assumes that you can only get 4.5% return on your money when reinvesting the difference in the payments. Which, we know this is easily overcame. I just used it to compare apples to apples. You would have increased your equity return by 8.148% ($2,037/$25,000) per year just by going interest only. You choose!
Your example assumes that the interest rate on the interest only loan would be constant for the 5 years, which normally would not be true. It also assumes that the investor would have the discipline to invest the difference in the income each month, which is also not true (this is very important as most people are not that disciplined). Finally, your example is during the first 5 years of the loan when the principal paydown is the lowest. During the last 5 years (or any other 5 year period), things would be QUITE different.
I agree that it takes discipline to achieve your investment goals. There are interest only products out there that have 1,3,5,7 and 10 yr fixed interest only periods. Also too, keep in mind your equity return diminishes as your equity position increases because your payment stays the same or increases over the twenty year period along with expenses. That is where you have to look at the opportunity cost of having that many eggs in that property. Leverage is not a bad thing if used correctly. But, your point is well taken.
Good discussion. I understand your point and agree with what you said. My personal strategy is to pay down the debt, but your points are definitely valid.
Hey,
IMHO Principle paydown is as much a function of risk reduction as it is return maximization. I know some commercial investors that are very successful that keep their portfolio at 50% leverage. Are they maximizing their returns for the money they have invested? Of course not. But a downturn in rents and/or depreciation is not something that sends them jumping out of windows, in fact they are positioned much stronger than most others that are more leveraged to acquire more property during down turns. If you have a portion of a property paid off, you can refinance to bring down the payments if necessary. I think too often investors focus on maximizing returns, and forget about the equally important side of minimizing risk.
What Sean L says is spot on. There is a huge opportunity cost when it comes to putting equity into a deal. If you can take your money and put into another deal and get a 14% return there is no reason to pay down principal. Granted the paydown does mitigate risk but the strength of that effect is a factor of the amount of leverage. If you are 90% leveraged on a deal a paydown is going to make a lot more sense. If you are 60% leveraged it just doesn’t make sense.
I work for a private REIT that leverages everything at 60% on a 30 year interest only note. Our target return is 9% cash on cash and a 14% IRR. It works great for us but we get pretty good rates, we got a quote a couple of weeks ago for 5.39% on a $55 million 5yr. interest only 30 yr. note. Back in the good old days (two years ago, LOL) when interest rates were low, we borrowed $28 million at 3.8% 5yr. I/O on a 30 yr. With those kinds of rates an interest only type of situation definitely makes sense.
I am new here and I am glad I found this forum,it is obvious there is alot of good info. I am new in the Commercial lending arena and have recently taken on placing a few commercial loans. I have a few churches and a commercial building looking to refi and cash out at around a 55-60%ltv . All good deals .My question is what type of rates assuming good credit and payment history should I be bring to these guys ? they are looking for 15-20 yr fixed good LTV’s (on the commercial) strong leases in place as well. Loan amounts in the Mid $2 mill range