Pssst - Wanna Be a Real Estate Millionaire? (Part 8)

Chapter 8: Commercial & Industrial

In some locations, the term “Commercial” is used to mean both retail and industrial properties. I choose to separate the two into distinct categories because they have completely different functions. Think of commercial as meaning retail stores and office buildings. Think of industrial as meaning manufacturing facilities. In the previous seven chapters, we’ve discussed residential properties. Now we’ll look at business-oriented properties.

As we move into more specialized-usage real estate, the risk factor increases. Everyone needs a place to live; not everyone needs an office or a manufacturing facility. Conversely, people move frequently. Once a business or a manufacturing facility is established, they are usually much more reluctant to move. So on the one hand, you have a huge pool of potential tenants but the turnover can be high. In the other area, you have a much smaller group of potential tenants but once they sign on the dotted line, they are usually very stable, long-term tenants.

My first experience in real estate was in 1957 when I bought a storefront on behalf of three brothers who operated a retail paint business. One of the brothers worked with me in the Advanced Engineering Staff at the Ford Motor Company in Dearborn. His other two brothers worked the paint business full time. They used me as the financier to expand their business. I had absolutely no idea what I was getting into and had zero background in real estate. After I collected the information on the storefront building and the details of the paint business, I went to an attorney who specialized in real estate transactions. Essentially, I bought a couple hours of his time to teach me what I was about to do.

What I was about to enter-into was called a Land Contract (as opposed to the similar sounding name but completely different entity called a Land Trust). Normally when you purchase a property, you get title to that property even though you may owe most of the cost to someone else in the form of a mortgage or trust deed. In a land contract, you do not get title to the property. The title remains with the seller but you do get a recorded interest in the property. The disadvantage to the buyer is if you miss- or are just late with one payment, you lose completely. All the prior monies you’ve paid-in are forfeit to the seller. The advantage of a land contract is that you can obtain real estate with a very small (percentage-wise) down payment. However, this advantage no longer holds the appeal it once did since today’s financing market is much more liberal than back in the conservative 1950s. My personal opinion today is that I would never enter into a land contract. There are too many acceptable alternatives from which to choose. In fact some states all but outright ban land contracts because they can lead to horrible abuse of would-be buyers.

Anyway, I did purchase the building in 1957 on a land contract. I put a nominal amount down and the brothers then paid me the cash flow I needed to meet the land contract payment schedule. Within a year, the brothers had been able to build their retail paint business cash flow to the point where they were able to cash me out and takeover the property. I received a couple of thousand dollars for providing the interim financing. Perhaps that early success is why I eagerly pursued Bill Nickerson’s suggestions with apartment buildings starting in 1960.

In the early 1980s, I operated my own investment advisory and financial planning business. I was also involved in a corporate relationship with a high school buddy who was an attorney. We rented our office space for a few years but decided we could improve our business if we owned our own office building. We found a very interestingly designed building that looked like an old western town storefront. In fact, it has been used as a prop for several western movies. There were a total of seven offices in the complex. We were able to rent the largest space to a State Farm insurance agency and the balance to other professional individuals. We collected enough rent to cover all the costs so we essentially had free office space for ourselves. When we both retired, we sold the building to an attorney in the mid-1990s.

Office buildings don’t have any specific shape or location. One property I tried to purchase was originally a private home located on a main highway. It had been used as a doctor’s office but the doctor moved to another city. I had a woman who wanted to open a daycare center in this town and we tried and tried to make this house into her daycare center. The problem was, the woman wanted to cram 10 pounds into a 5-pound container. There was just no way I could remodel the interior of this house to provide the space she needed to accommodate the class sizes she wanted. Had I been able to satisfy her space requirements, the rental income alone would have repaid the total cost of the property in 4-3/4 years. I was smart enough not to buy the building without first having a tenant committed to long-term usage. If you’re in an area where there is high demand for office space, perhaps you don’t need to be quite so reluctant.

One of the best properties I’ve ever purchased is a 5000 sq. ft. industrial building on a 2-1/2-acre parcel. The prior owner had purchased it a few years earlier but now had other financial obligations for which he needed cash. The existing tenant operates a heat-treating facility and has a dozen furnaces in the building. These are not the kinds of equipment that one just ups and moves to another location. Before I bought the building, I had a long discussion with the tenant and was extremely impressed with his business plan. He has been in the heat-treating business for over 20 years and loves what he does. He’s been operating his own business for four years. His plans for expansion dictate a tripling of square footage to 15,000 sq ft that he believes is optimum for his business. He tells me he could go even larger but the higher labor costs would then reduce the efficiency of his operation. Here is a large parcel that would easily accommodate a new 15,000 sq ft building without having to demolish the existing 5000 sq ft building.

I bought the building and then immediately executed a new, 5-year lease with the tenant. The lease provisions provide for the same, current rent for the first two years. Thereafter, the rent can be increased in accordance with on-going inflation. Even if I never increased the rent, the tenant will repay me the total cost of the property in just under four (4) years. That’s a 25% triple net return. Furthermore, we have now entered into a financing package to purchase two more furnaces plus other allied equipment so that he can offer more services to his customers. He will lease the equipment from me for one year on a master lease and then he has the option to purchase the equipment from me. The cost of the equipment plus installation will total $150,000. Once the equipment is installed and operating, the new gross monthly income generated just from this equipment alone will approximate $90,000. Operating costs are simply minimal energy costs. Would you purchase equipment that would earn its total cost in just 2 months? Talk about a return on investment!

So I didn’t do anything unusual here except be open to profit opportunities. I think the former owner made a big mistake selling this property to me. A former tenant had used this building to manufacture decorative paving brick and they left a huge Portland cement hopper tank on the property. That tank is for sale and will probably generate another $5000 in net cash return to me. This is all happening now, circa 2005, (when I wrote this section). My point is opportunities are always out there. You just have to be receptive. It does require that you invest in yourself and become knowledgeable on how to handle these opportunities. Hopefully you are beginning to realize that this book will help you quickly get up-to-speed.

NOTE: Stay tuned for Investor vs Landlord options