Commercial Real Estate

[BunsGettingFirm]

I did a quick search of the board, but I couldn't find much in terms of commercial real estate. Most of the links on the web are very useless. If anyone has some good links, book recommendations, or even actual experience, please share.

 

[Martha]

Hey Buns, No more veal?

What are you thinking of with respect to commercial real estate? Buying a building and renting it out? Buying into a REIT? Into a private placement with other investors? A TIC (tenants in common) entity?

 

[BunsGettingFirm]

Martha,

Please check your private messages.

Well, not that I was ever fat, but school has a way of running you down to the bones.

 

[FlogBlogger]

I, too, am all ears to those with sage advice. A landlord with a NNN lease agreement receives similar benefits (and advantages) as an annuity provides. The $1M commercial pad I'm looking at would throw off $6K/month on a ground lease, and twice that if a shell is first built (as Starbucks requires). Secured by tenant improvements, that makes for a nice stream of income over 15-20 years (plus options), and in all events, one still owns the land.

 

[tryan]

MIT has free real estate course material. Much of it slanted towards commercial RE. Got about 1/2 way thru it .... good high level material.

good luck.

http://ocw.mit.edu/OcwWeb/Urban-Stu...and-InvestmentFall2002/LectureNotes/index.htm

 

[BunsGettingFirm]

Tryan, this is exactly the kind of primer material I was looking for! Thanks!

 

[tryan]

Glad if it helps .... seemed to be written by students, for students.

Experiance trumps "schooling" IMHO.

 

[Martha]

One issue about the triple net lease. You have one tenant. If that tenant doesn't pay, you still have to pay your mortgage. Company stores, rather than franchises, are often a better option.

Recently I represented a lender who has made a number of loans to a guy who built Burger King restaurants for franchisees and leased them out on a triple net basis. One of his tenants went belly up. It took him nearly two years to find something else for that building plus he had to put a bunch more money in so it didn't look like a Burger King anymore. Fortunately, the guy was rich and could take the hit.

 

[Tracy42]

Over the last 18 months my DH and I have purchased two commercial properties. As Martha cautioned, we stay away from single tenant properties. One property has 3 tenants, the other has 7 tenants. We lean toward newer (not more than 5 years old) buildings to minimize the maintenance issues. My experience is that it is key to work with a well established commercial real estate agent, as both of the properties we purchased never got listed or offered to the public at large. Our agent developed both of them from her contacts.

With our local banks, the minimum downpayment is 15%. I have found that with larger properties (over 1 million) if you have 20-25% to put into the downpayment, you may be able to get a better interest rate using a national commercial real estate lender, however, we went the 15% down route.

I establish a minimum cash on cash return rate of 7% before I will consider an investment (for example, if I put $75,000 in the downpayment and financing expenses, the rents have to generate $5,250 a year after all expenses are paid). This was easier to get when the interest rates were 6.5%. At 7.2% currently, the pool of potential opportunities gets smaller.

There is also benefit from equity appreciation, but we don't factor this into the equation. Obvioulsy it helps down the road, but what if the real estate market flattens or turns down? To be considered by us, the property must cash-flow from the start.

The two commercial loans we have both have a 5 year term, and are on a 20 year amortization. This was new to me, since my only previous experience was with residential loans that had 15/30 year terms and amortization schedules. Basically the loan must be refinanced every 5 years.

For us, another benefit is that the income from the rentals is passive (no employment tax). As well, it is mostly shielded by the building depreciation write-off. In effect, we get the income tax-free. Tracy

 

[poyet]

As well, it is mostly shielded by the building depreciation write-off. In effect, we get the income tax-free. Tracy

As I directly own the buildings as personal properties I cannot do that unfortunately (I still can write off maintenance but not amortization).

Do you own the buildings in the shelter of a an estate company or trust ?

 

[tryan]

I establish a minimum cash on cash return rate of 7% before I will consider an investment (for example, if I put $75,000 in the downpayment and financing expenses, the rents have to generate $5,250 a year after all expenses are paid). This was easier to get when the interest rates were 6.5%. At 7.2% currently, the pool of potential opportunities gets smaller.

There is also benefit from equity appreciation, but we don't factor this into the equation. Obvioulsy it helps down the road, but what if the real estate market flattens or turns down? To be considered by us, the property must cash-flow from the start.

The two commercial loans we have both have a 5 year term, and are on a 20 year amortization. This was new to me, since my only previous experience was with residential loans that had 15/30 year terms and amortization schedules. Basically the loan must be refinanced every 5 years.

Wow ... 7%. You're slicing this pretty thin IMHO. I mean, CD's are paying 5.5% ... why take the risk? I won't touch anything that produces less than 20% cash-on-cash. And, therefore, have not purchased a property in years ... numbers simply do not work at these inflated prices.

Simply too many unknowns: Have you considered what'll happen when you refi in <5 years and the rate jumps 2-3%?

 

[Nords]

As I directly own the buildings as personal properties I cannot do that unfortunately (I still can write off maintenance but not amortization).

I don't know which country you're doing that in, but the IRS assumes that you're depreciating real estate (and taxes you accordingly) whether or not that's actually the case.

 

[Tracy42]

Tryan, I guess we all have different investment styles! My definition of cash on cash is what I have in my checking account at the end of the year after all my expenses are paid. In addition, my tenants are paying down my mortgages. If you factor that in, then my return is very close to your 20% minimum on both of our properties.

If interest rates jump a couple of points by the time we have to refinance, then my income level with remain flat until they come down and I get a chance to take advantage of that. The principal paydown over the mortgage term will cover a 2% swing in rates.

 

[tryan]

(for example, if I put $75,000 in the downpayment and financing expenses, the rents have to generate $5,250 a year after all expenses are paid). This was easier to get when the interest rates were 6.5%. At 7.2% currently, the pool of potential opportunities gets smaller.

No ... we have the same definition. Just different tolerances for risk. Should also add that if I don't pay cash for the property, I put a minimum of 20% down (for the prefered rate).

I honestly hope this works out for you (RE is 75% of my NW). But I certianly didn't see the last 5 years as a buying opportunity.

 

[poyet]

I don't know which country you're doing that in, but the IRS assumes that you're depreciating real estate (and taxes you accordingly) whether or not that's actually the case.

Well, Nords it depends on how you own the property. In France, if it is through a company, then you amortize, etc. (must be pretty close to what you said with the IRS). But, if you own as an individual, then you're taxed on income (with tax brackets), then you have an additional flat tax on revenu of 11%, i.e. CSG (Contribution Sociale Généralisée) on top of tax on income and furthermore not only you do not depreciate the asset (i.e. amortization), but you must raise its value to mark it to market every year, before you pay a tax on wealth on it (with brackets again topping @ 1,8% every year when wealth > 15M€). You also have a local tax on the property (i.e. foncier). Of course you can substract from raw income, maintenance costs. In the end, my net income on RE after taxes is miles away (when adding up all these taxes) from the raw income (65-70% taxes), but the properties (at the moment) rise more than inflation and most of the capital gains remain unrealized and therefore untaxed until you sell. If you wait 15 years before selling then no tax. No tax on cap gains on principal residence as well. To make a short summary !

 

[Tracy42]

I honestly hope this works out for you (RE is 75% of my NW). But I certianly didn't see the last 5 years as a buying opportunity.

Thanks Tryan. It sounds like you've made some good investments. I can't argue with you, 20% cash on cash is impressive. Wish there were some of those deals around here! Are you concerned at all with 75% of your NW in real estate about lack of diversification? Are your properties in different areas/sectors to spread the risk at all?

In our situation, real estate only makes up about 15% of our NW. Both my DH and I are still working (another year at least). It made sense for us to maximize the real estate income up to the maximum tax free income, but not above that. Rather than pay more down to get the better interest rate up front and creating taxable income, we are maxing out retirement accounts. We will probably buy 1-2 more properties and then we are probably done (unless I run across one of those 20% deals!) Any further investments in commercial real estate will be through 1031 exchanges after that. Tracy

 

[tryan]

Are you concerned at all with 75% of your NW in real estate about lack of diversification? Are your properties in different areas/sectors to spread the risk at all?

Not surprizingly, with the last 10 years of appreciation I am lucky to pull 6-7% (equity to cash). Sooooo selling certianly makes alot of sense (for me to diversify). Any vacancy will be sold off.

Yeah, having most of the eggs in one basket is certainly a concern. Dumped all the muti familys and paid down the loans on the single families (5) I had. Then developed some waterfront land for a sixth unit. If the last year is any indication, it doesn't seem to matter (inner-city or rural water front) the tide is going OUT and everything is dropping a bit. Good thing for those RENTs!

The 1031 exchange is a good deal. Traded an inner-city duplex for waterfront land a few years back. My accountant is quick to remind me that the exchange only DEFERs the tax. Would need to live in the unit 2 years to exempt the tax.

Good luck.

 

[Tracy42]

The 1031 exchange is a good deal. Traded an inner-city duplex for waterfront land a few years back. My accountant is quick to remind me that the exchange only DEFERs the tax. Would need to live in the unit 2 years to exempt the tax.

True, you need to keep exchanging to keep deferring the tax on the gain. We did that with one of the properties we bought as well (traded a beachfront condo for a commercial strip mall). We had about 260K in equity in the condo ( only about 100k in capital gain when all was said and done--Hurricane Ivan was not good for Alabama beach front properties!). We leveraged the equity to buy into a 1.5 million fully-leased strip mall (that we can drive by and see within 5 minutes instead of 10 hours.)

Sounds like you are into residential real estate. We tried that several years ago, but it was not my cup of tea. I did not like dealing with the tenants, collecting the rents, etc. Dealing with businesses and business owners has been a whole different experience. So far at least, the checks come like clock work in the mail. They keep the premises looking good because they are trying to attract customers and stay in business. They let you know if there is a maintenance issue before it becomes a real problem. I am sure at some point in the future I will run across a deadbeat, or rent to someone who goes out of business, but it sure seems like a lot less work so far. The margins are not as big as you can make on residential real estate, though.

 

[brewer12345]

Tracy, how did you find the strip mall to invest in? As the pile grows, I become increasingly interested in commercial real estate, but I've no idea how to even find it.

 

[Tracy42]

Both properties were purchased using an agent. I met her several years ago when looking for an office space for my DH. About 2 years ago I sat down with her and told I was interested in diversifying through real estate. She started running down some opportunities for us. I told her how much of a downpayment I had available, and what type of real estate I wanted (not residential). I knew enough to be dangerous, so I asked her a ton of questions. Both buildings we ended up buying through her never made it to the public listings. She brought both opportunities to me first before making them available to other clients (or at least that's what she told me!) or listing them publicly.

The first stip center we did was a smaller one. 3 tenants, $450K purchase price with $67,500 down. I probably ran the numbers on 15 other buildings before we bit the bullet on this one. Now that we are "qualified buyers" (meaning we were not just wasting her time shopping but never buying) she is very motivated to bring us other opportunities.

The 2nd building was a true gift. We were sitting on our condo in Alabama that had just reopened for rentals, but the bottom dropped out of the real estate market because of all the hurricanes. My agent knew that until I could move that condo, I was not in the market to buy anything else. She put together a true exchange for us. We literally traded the condo for the strip center (plus a big mortgage).

Now that we've purchased the 2nd building, we have developed a connection with the previous owner, who is a developer. He's got two other similar projects he is developing, where he is going to put up the buildings, fill the spaces with tenants then sell the properties. One contact leads to another.

There is also a commercial property "MLS" system, called loopnet.com I am always checking that as well and if I find anything I want more information on, I shoot my agent an e:mail and ask her to get the financials.

The agency we work with also leases out space for owners, and I plan to make use of those services when I need to fill a vacancy.

I am no expert by any means. I'm learning as we go along. Maybe someone else has some additional experience/insight?

 

[brewer12345]

Do you manage the properties yourself? How much work is it?

 

[Tracy42]

I manage them myself, with the help of my sister and borther in law, who I pay a small sum (less than a property manager). I may reassess that once I retire, but while working full time I find I need the security of a back-up. Honestly, there hasn't been much to deal with. We had some grafitti on a couple of doors, we had a roof leak and had to call someone out for that. We had to arrange for lawn care and snow removal. My strategy is to buy newer buildings (you may sacrifice some potential profit margin) to minimize maintenance issues.

I got a list of recommended contractors from my agent, and we use the phone book and get estimates. That's where my sister comes in. She runs all that down for me.

One of the buildings is true triple net, and I spend about 30 minutes a month transfering funds and reconciling payments with expenses.

From what I've seen, a property manager will charge about 5% of the gross lease amount, which really cuts into the profit margin at the beginning. I may re-look at this down the road once I start having some vacancies. As I get deeper into this, I can forsee that I will have to learn something about dealing with contractors and building out office/retail space to suit new tenants as I get some turn over. That's a challenge, but I'm amazed how much I've learned over the last 2 years and how much more comfortable with it I am as I review each new potential deal.

 

[poyet]

The first stip center we did was a smaller one. 3 tenants, $450K purchase price with $67,500 down.

Tracy, I'm impressed by the leverage you take, of course when everything goes on well it is a good way to fasten growth. I usually invest a down payment of 50% and only invest in commercial properties (downtown city shops, hotel, warehouses and the like).

Commercial RE is the best investment I know, but of course you need to know the market you invest in and the prospective demography of the place (among other things).

Nevertheless, as with investing in stocks, you need to be prepared to when things go astray. For example, over the last 4 years I had in the same warehouse (1000 square meters) two tenants that went belly up. The last bankruptcy this year (April) was the most painful. It took me 6 months and going to court to get back my keys (as the assets were auctioned in the meantime), 35.000€ of rents lost over the six months, 90 tons (yes tons) of garbage left behind the production of curtain walls (what the tenant manufactured) and to remove, plus all the chemicals so hard to get rid of (polymers, resins, liquid latex, unkown stuff stinking acid, aceton and the like ?), etc. plus 6000€ of local taxes on the property left vacant. I had to clean everything, to repaint the facade, still welded yesterday "calendrite" to patch holes on the huge roof, will remove large stacks of clays that deposited and clogged the evacuation system of the roof today, etc...

Still empty, nine months after the last check, no income since only expenditures + lawyers. Hopefully, when I ERed, I paid down all mortgages to sleep well, so it does not cost me more than the loss of income, the lawyers (to no avail so far), the local taxes + tax on wealth (hate that one) !

Fortunately, I just had one on the several properties I own which ditched at a given time.

Commercial RE is great, but take care, it can also go wrong

 

[Nords]

Tracy, how did you find the strip mall to invest in? As the pile grows, I become increasingly interested in commercial real estate, but I've no idea how to even find it.

I don't know how close you are to your firm's customers, but my BIL the CPA has learned a tremendous amount about businesses and investing from his customer's tax returns.

When he goes over their returns with them he asks a few tax-planning questions of his own. Almost everyone is happy to brag talk about it, and with their 1040s in hand it's pretty easy to determine who's credible and who's just boasting.

I'm thinking that I might find commercial REITs more profitable than going it on my own...

 

[FlogBlogger]

I'm thinking that I might find commercial REITs more profitable than going it on my own...

Risk aside, I'll take a NNN over a REIT for profitability.