My wife and I are ready to begin real estate investing. I have read a lot and have some broker contacts and will be starting an LLC (Texas) before March is over. We hope to start making offers before July ends. What I would like to request is some sanity checks on the business plan we’re thinking of.
What we would like to do is purchase a retail/office establishment that is looking a bit run down and has some vacancies and polish it up to attract new tenants. We would be in the buy, fix-up, and hold for cash flow business. We are in the Austin area which is growing rapidly. We have some capital (up to 40k) and excellent credit rating. In addition we will bring my brother into the business as he has worked 16 years performing retail building maintenance, construction, and home rehabs. Between my wife and my assets and his experience the retail rehab seems like a good model to work with.
Here are some aspects I would like to get some seasoned advice on.
- Given great credit, good net worth, and 20-40k to apply to purchase, what’s a reasonable range to be looking for? In loopnet I see lots of >1million properties but that seems out of range. Is a 1mm property in range and if so what hypothetical offers would you extend given my described situation?
- Is it true that valuation of retail/office is based on the current NOI? That is, if a somewhat rundown retail strip had 50% vacancy, say 3 out of 6 occupied, the amout I should offer is based on the NOI of the 3 current tenants. I only want to deal with positive cash flow situations and it seems that it would almost naturally be negative if paying for empty space. It could be a really small positive cash flow as the rehab and leasing of empty space is where we hope to gain value and improve cash flow.
- Outside of the two commercial broker contacts I have, would driving around and finding obviously neglected strips be a method for this business? If so, how do you find the owner to research if they want to sell?
- What are some proven methods for attracting potential tenants once the sprucing up is under way?
Thank you for taking the time to respond.
Cedar Park, TX
$20K-$40K might not be enough. Closing costs alone will probably be over $10K.
I would say that $1M property is out of range. If you use a bank loan, you will have to come up with a 25%-$35% down payment. The down payment will vary on the interest rate offered and the current Cap Rate. The bank will discount the current rent by 5-10% (for vacancy) and bump up the expenses by 5%. So if you find a $1M property with a current Cap Rate of 8.5% then you will need 25% down payment, assuming tha loan rate is 7%. Now if the cap rate is lower than you’ll need more funds and if it’s higher you will possibly get away with 20% down.
Vacancies will definitely hurt. You would rather get somekind of tenants than no tenants. Also if the property needs repairs the bank will force you to complete the repairs prior to issuing a loan.
You could have the seller or someone else finance a piece of the loan and you won’t have to put up so much out of pocket. It’s not that easy to find this arrangement since you first have to find the seller who will finance a piece of the purchase price and then find a bank who will be ok with this type of arrangement. It won’t be easy with $40K.
You are probably better off looking for a seller who is willing to finance a large portion. A seller who is very desperate, who just wants to get out. You could possibly assume the seller’s existing mortgage and have the seller finance the rest. In this case all you need is money for remodeling and closing.
Having great credit is good, but you do need more funds for downpayment.
Not to discourage, but doing add-value retail and office investing without a lot of cash is going to be very difficult. Add-value retail can be very risky, and lenders will be cautious. I recently looked at a short-lease(2 years with 10 years of options) single corporate tenant property and the banks wouldn’t touch it; if the tenant didn’t exercise an option, you’ve got a massive dark property. The bank is self-interested of course and wants to protect their investment. They want to see stability for any large loan. They know how risky high-vacancy retail can be, especially with a weak or dark anchor tenant.
As Eugene stated, your best bet may be AITD(all inclusive trust deed) in addition to a seller second, a way of assuming a seller’s loan without invoking the alienation clause, unless you find a seller with an assumable loan at a favorable rate with small or no assumption fee. You will need a very motivated or very trusting seller who is willing to be second to the bank and walk away from the closing table without any cash.
However, if a seller is desperate enough to want out of a property with nothing but a note, be very careful. If they are in trouble with their current debt load, and you are looking to assume that debt and add new debt on top of that, you better know exactly what you are doing. It might be that the seller doesn’t have a clue about finding tenants and the property is easy to lease up and add-value, but don’t bet on it.
I would recommend the following strategy combination for maximum safety and profit with $20-40k to invest(you will want to use none of this for down-payment in your case–don’t forget one of the key aspects of lease-up, which is tenant build-out, which will cost you money) :
Find a small struggling multi-tenant retail center. Shoot for $300-500k.
Make sure the owner hasn’t employed professional help to lease-up. No listing with experienced commercial broker, no attractive sign out-front. If owner has listed with a good broker or has advertised well and the property is still vacant, stay away for sure. It will likely remain vacant.
3)Look for basic add-value elements: are there cigarette butts all over the parking lot or ruffians hanging out at all hours? What basic (and cheap) changes can you make to the property that will make it more attractive to consumers and tenants?
As mentioned by Eugene, a seller who is willing to do a wrap-around and seller second.
An average to above-average strength local residential market. For reasons it would be too detailed to go into here, nothing affects retail more negatively than a struggling housing market. If the local residential market is struggling, it might make more sense to look into a small warehouse/distribution center in the $300k-500k range.
Minimal to no deferred maintenance. Mechanicals and structure need to be sound.
Find out who and where the competition is and what their vacancy rate is and who their tenants are. Those tenants probably won’t be your tenants anytime soon. Pull demographics and traffic counts for your target property. Watch out for declining population, high unemployment, and lower than average household incomes.
8)Try to tie up the property with a letter of intent with the maximum amount of due-dilligence time the seller will accept. Work hard to find tenants who will letter of intent to lease at your property. If you don’t find an additional tenant during this period, be even more cautious about your acquisition.
- Have fun! That’s the whole point of investing, after all.
Normally need 25% to 30% down. Can be less.