Even the most bearish economist is predicting that commercial real estate prices will fall up to 40 percent from peak to trough. However, the data released yesterday from Moody’s Investor Service shows that in April commercial property prices plummeted a record 8.6 percent. According to Moody’s data, commercial property prices fell a total of 29.5 percent from their highs in 2007. This leaves another 10 percent drop in prices if the most bearish economists are correct. In my opinion, much of this drop was due to a speculative credit bubble that caused commercial property buyers to purchase properties that would never produce a positive cash flow, even assuming a strong economy and strong demand for commercial real estate.

I believe that most of the declines in commercial property prices that can be attributed to the credit bubble have mostly taken their toll on prices. But, I surmise that we could experience an even greater decline in commercial property prices due the fact that the economy is fundamentally unsound. If one closely examines the fundamentals of supply and demand for the commercial property sector, the prospects for continued price declines becomes readily apparent, especially in the retail and office building sectors of commercial real estate.

Background to a Crisis

During the speculative credit bubble, developers built many more office buildings and retail stores than could possibly be sustained. Now that unemployment is in the double digits and major economic sectors like the automotive industries are going bankrupt there is less demand for commercial property. There have been many large, well known, retail brands either going bankrupt or severely cutting back growth projections. In a small city, near where I live, there are at least fifteen Starbucks. How many Starbucks stores can one small city support? Circuit city is out of business, Brandsmart may be next. Car dealerships are closing their doors around the country. These are all commercial real estate tenants whose absence can’t easily be filled. The list goes on and on. If so many large retailers are going out of business or curtailing operations then there will be even less demand for all of the vacant commercial retail space.

Commercial Real Estate Breakdown & Predictions

As local, state and federal governments go deeper into debt they will be increasing taxes even further on businesses and property owners. This means higher taxes for the owners of commercial real estate. If the costs to hold a property increase, then its intrinsic value must decrease.

I would challenge the 40 percent figure and would argue that prices could drop even more due to the dismal state of the economy at large. I would go the record to say that the commercial property sector could see real price declines of up to 70 percent from peak to trough. The worst might still be ahead of us.

Source: Reuters
Photo Credit: strangelv

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• ‘Wave of foreclosures’ to hit commercial sector, Insider Q&A; told (lansner.freedomblogging.com)

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Tags: Commercial, commercial property, commercial real estate buying, commercial real estate prices, commerical property investing, Retailing

Many apartment buildings are now facing foreclosure because of falling prices, stricter underwriting guidelines and 5 year mortgages becoming due. For the astute buyer of apartment buildings these apartment building foreclosures could represent an investment windfall.

As a glaring symbol of the burst bubble in national residential real estate prices, the National Association of Realtors announced recently that a full 63% of homeowners in Las Vegas are now “underwater” in their mortgages. This simply means that they owe more than their property is currently worth. For many of these people, it simply makes no economic sense to continue paying for their mortgages when the underlying asset is no longer worth what they owe. This situation will probably lead to further foreclosures and further declines in real estate prices. As all eyes are currently watching the steep decline in residential real estate prices and rising foreclosures, the commercial side of real estate has hardly begun to realize the problems that may be looming on the horizon for many apartment building owners.

Homeowners in Las Vegas, for example, who are able to continue paying their mortgages may decide to hold on to their property for a few years and hope that real estate prices recover. They are able to make this decision because, presumably, they have 30 year mortgages. In contrast to residential mortgage holders, many investors in commercial real estate are holding on to 5 year mortgages. This means that they will be forced to refinance their properties when the notes become due and it couldn’t be happening at a worse time. Many apartment buildings rose in value right along side residential real estate prices and too many of these owners paid too much for their properties because they figured that as long as they were seeing a net profit every year from their rent collection then they had nothing to worry about.

Market Conditions Lead to Great Opportunity in Apartment Market

During the real estate investing frenzy apartment building buyers didn’t take into account the possibility that real estate prices would drop so precipitously is such a short period of time. Now, many apartment building owners are facing a dire situation. For example, let’s assume an apartment building investor purchased an apartment building in 2005 for 1 million dollars. He came out of pocket for $200,000 and he financed the purchase with a 5 year balloon note that becomes due on January 1, 2010. He financed 80% of the purchase price. In the last years, however, the market price of his apartment building has dropped 20%. It is now appraised by the bank as being worth $800,000. Unfortunately, when he goes to the bank to get a loan, the loan officer tells him that the bank has changed their underwriting guidelines and they are now only willing to finance 70% of the appraised value of the property. Now, he is only able to finance $560,000. The problem is that he still owes just around $800,000 on the property. The difference between $800,000 and $560,000 is $240,000. Unless the apartment building owner can come out of pocket to pay this additional $240,000 to the bank then he will eventually be forced into foreclosure. It is safe to assume that many apartment building owners will make the same choice that thousands of home owners have, to walk away from the mortgage and the property, chalking it off as a lesson learned.

For the first time buyer of apartment buildings, this could be a windfall in the making. There could be thousands of properties, in good condition, appearing on the market at rock bottom prices.

Tags: apartment building foreclosues, apartment building investing, apartment foreclosures, buy apartment buiding foreclosues, how to buy apartment building foreclosures, how tobuy apartment building, invest in apartment foreclsoures

So you’ve got five residential tenants.  Joe consistently pays late.   Christine got in a fight with her boyfriend and kept everybody awake on Christmas Eve.  Alex leaves his trash out in the halls.  Richard calls you around the clock to complain – about the other tenants, but also about the traffic noise, about the heat, about the shower, etc.

And then there’s Mary, the undemanding tenant.  The tenant you love.  Mary never complains.  Mary always pays.  Mary is your buddy.  Do you have to worry about Mary?  Yes.

The other tenants demand your attention.  Mary never gets any attention because she never causes a problem.  However, your lack of communication with Mary means you don’t really know what’s going on with her unit.

Mary may, in fact, be very unhappy, and planning to go.  A lot of people are like this – they don’t complain about a situation until the day they decide to walk out of it.  In that case, the first call you get from her will be the one saying “I’m leaving at the end of my lease.”   Even then, she may not say “I’m unhappy.”  But suppose she is?  Suppose she had real complaints and issues that you could have fixed if only you had known about them?  You’d be kicking yourself when you got the “I’m leaving” call, because it came too late.  Offering to fix the problems in response to the “I’m leaving” call probably won’t work, because chances are Mary has already signed a lease somewhere else.

You Must Call First

Because Mary’s not going to call you, you have to call her.  Do this every couple of months, and any time a problem happens elsewhere with the building that might affect her.  These are “check-in” calls.  You can ask how she’s doing, if she was affected by the other problem (assuming that prompted the call) and so on.  If your call was prompted by an issue elsewhere in the building, let her know what you are doing about it.

By making frequent calls, and soliciting her views, you are letting her know that it’s okay to complain.  It’s highly unlikely she will have any concerns to address at first, but eventually she will open up.  Now bear in mind this is not a bargain – “If I pay attention to you, you won’t leave.”  However, you are increasing your chance that she will stay.

I must confess, there are times I’ve been really reluctant to make these calls!  If it’s the end of the day and I’ve dealt with four or five major issues, the last thing I need is another potential hassle.  But consider Mary’s value.  She’s the best tenant I have.  If she leaves, I’ll have a heck of a time replacing her with someone of the same quality.

What if She Just Doesn’t Notice?

It may be that Mary seems satisfied, not because she is reluctant to complain, but because she just doesn’t notice problems.  The whole place could be falling down around her, and she would really think everything was fine.  Great, right?  Let me repeat:

The whole place could be falling down around her, and she would really think everything was fine.

Since you don’t want the whole place to fall down, you need to make sure this isn’t the case.  Little problems often develop into big ones, especially with plumbing, pests, or electrical work.  To prevent this, you must – at a minimum – schedule inspections of Mary’s unit with the same frequency as the others.  When inspecting Mary’s place, you’re not looking for problems she caused as much – those are unlikely.  Rather, you’re looking for problems that happened for other reasons.

You may also want to take a few minutes to teach Mary about little signs of trouble that she can catch early.  Frame it as a matter of avoiding inconvenience – “if this turned into a major problem, you wouldn’t be able to use your stove for a few days.”

Don’t Take Her for Granted, or Give Her a Break

I’ve noticed before that when contractors form a friendly relationship with you, they may start taking your good nature for granted.  Rather than getting special treatment from them, you’re moved to the back of the line.  We have the same tendency to do this to our best tenants.  When they do have an issue, because they’ve been so nice to us in the past, we may say “Mary can wait a little bit, she’s patient.”  But that’s entirely unfair to Mary and may cause trouble for you down the line.

How about a break on the rent?  I don’t mean a one-time break, allowing a late or partial payment without penalty.  That’s probably not going to come up with Mary.  I mean not increasing her rent at the same time you increase everybody else.  I personally would raise her along with the others.  The good reason not to (you want to keep her) is overshadowed by the good reasons to.  One good reason is that having everybody pay the same reduces resentment among tenants.  Another is that if you charge market rate but provide superior service, you’re still giving Mary a good deal.

Tags: apartment, housing, lease, tenant rights

Finding qualified tenants is one of our biggest challenges. Last week, I talked about marketing empty rental units as a big funnel. Why a funnel? Because one end is an enormous group of people – the people who might rent a residential unit. The other end is just a couple of people – qualified prospective tenants who want to rent your unit. Your goal is to get the people you need from the top to the bottom of the funnel as quickly as possible.

Each level of the marketing funnel demands different tactics. The first step is finding people who want to rent a unit like yours, and eliminating those who definitely don’t want your unit. In last week’s post, we wrote an effective ad that included all the basics.

The ad said what kind of unit it was, laid out the basic features, and spelled out what would be required of tenants – a one-year lease, and passing landlord, employment, criminal history and credit checks.

Our next mission is to get this information in front of people who are looking for it. There are many ways to do this, and no reason not to use all of them. However, you want to prioritize well to minimize your time.

Thinking like a Prospective Tenant

What would I do if I was looking for an apartment in the area where I live?

• I’d look on the Internet.Maybe it’s just because I’m generally net-savvy, but this is always my first choice. Just for fun, I typed “NH seacoast apartments” into Google. The two sponsored links at the top were for a local property manager, and for www.apartmentguide.com. The first three non-sponsored links were for www.sublet.com, www.directorynh.com, and for Craigslist.Putting my landlord hat back on, I am really impressed with that local property manager. However, in order to have my unit show up on their website, I suspect I’d have to hire them as my property managers. The others are certainly worth looking at. First, ApartmentGuide.com seems geared toward big rental communities and doesn’t explain how much their charge on the web site. Sublet.com, on the other hand, is – free! I like free! (They do charge for some services, but you really can post an ad for free.) DirectoryNH.com is not free, but it’s not that expensive either, although their posting policies are a bit complicated.Of course, since you probably don’t have your rentals in the NH seacoast, you need to do your own Google search.
• I’d look specifically at Craigslist.Wearing my prospective tenant hat, I know that lots of people find what they want on Craigslist. Wearing my landlord hat, I know that listings are free unless I am renting in New York City. Craigslist’s two downsides are that it can be hard to search, and that I must repost every couple of days for maximum impact. These are not major downsides.
• I’d drive around. As a prospective tenant, I like driving around because it gets me out of the house. Unfortunately, it’s also often a waste of my time. I see “For rent” ads and I don’t know what the place is like, how much it costs, and so on.On the other hand, as a landlord, I like “For rent” signs because they only have to be put up once. I prefer really big signs because they let me put out some extra information (how many bedrooms, how much is the rent).

  The only additional things a For Rent sign can show your prospects are the quality of the neighborhood and the outside of the building. This is actually really important to some tenants, particularly single women and families with young children – something to keep in mind.

• I’d read the paper classifieds. All around the country, newspapers are having layoffs or even going bankrupt. One reason for this is that they get far fewer classified ads as people switch to services like Craigslist. Wearing my prospective landlord hat, I’m not going to spend a lot of time on the newspaper. After all, chances are I can find a place using the free services mentioned above.Wearing my landlord hat, I’m not going to spend any money on paper classifieds, with one exception. The one exception is that I might advertise in a very small weekly shopper that appeals to just one or two towns. My prospective tenants may very well pick up the weekly shopper, since it won’t cost them anything and they find it everywhere. But I will only run these ads if the shopper is free and it includes my town and at most one other. Also, I won’t run the ad for the first two weeks that my rental is available. I’ll focus on free listings instead.
• I’d check bulletin boards. As a prospective landlord, I like bulletin boards because they are free, will let me post a big, detailed ad, and will generally stay up for as long as I want them to. Also, since not many other landlords are advertising on them, my ad will tend to stand out.These tactics apply well to residential rentals. Of course, things will change in unusual circumstances. If you are aiming for college students, for example, bulletin boards (as well as signs taped to telephone poles, etc.) make a lot more sense. As you might expect, the rules are also completely different for commercial rentals – as we’ll discuss next week.

Tags: apartments, landlord, marketing, rentals

I am in a very fortunate position right now.  All of my 13 units are rented, and all the tenants are paying on time.  It’s great!  And it’s not going to last.

I know that because even in good economic times, I’ve had a couple of tenants every year who found that at some point, they just couldn’t pay their rent.  And these are not good economic times.  In fact, I am really amazed that my one retail tenant, selling antiques and other non-essential items in a very blue collar town, is still paying on time.  And I have no idea how many of my residential tenants are dealing with impending layoffs, loss of overtime, or other issues.  I certainly know that most of them don’t have financial cushions they’ll be able to use if they lose some of their work income.

I can handle the “can’t pay the rent” call in many different ways, but they boil down to three options.  First, I can be hard, telling the tenant the rent is the rent – pay in full on time, or be evicted.  Second, I can be soft – but that may mean that the tenant never pays, and I’m out of pocket forever.   Third, I can find some middle ground – which is probably what I will do.  There are a million variations on that “middle ground.”

Make your plan before the call comes

I’m a big believer in rules to manage my behavior and guide my decision-making process.  In this case, rules will overcome an emotional reaction that might lead to a bad decision.  They’ll also keep me from making a snap call that could turn out to be wrong.  Remember, as landlords, our bad decisions have long-term consequences.

The emotional reaction can be anger (“How dare Carol not pay me when I depend on her money to pay my bills!”) or sympathy (“Poor John - $4,000 in medical bills!”)  Which reaction will I have?  That depends on the tenant’s story, and probably also on how the rest of my day is going.  In other words, I should ignore it and concentrate on making the best business decision.

Finally, why the middle ground reaction – why am I probably going to make a temporary deal?  Well, I already know I’m not going to go soft and let the tenant take advantage of me forever.  And I probably won’t boot the tenant right away, either, simply because that leaves me with a vacant unit – which in a snowy, bitterly cold winter, along with a bad economy, is likely to stay vacant for some time.

Here are the hard and fast rules I’ll establish up front.

• I will never give a tenant an answer right away (upon the first phone call).  Even though I may know what I want to do, I will sit on the decision for a day.  Why?  First, coming back with an answer right away, especially if I’m offering the tenant a generous deal, may mark me as a soft touch.  Second, waiting gives me a chance to really think through my decision.
• I will insist on a written agreement.  This is essentially a temporary change to the lease, signed by me and the tenant, which means if the tenant violates it, he can be evicted.
• I will not let the tenant get more than one month behind in rent.  This way, if the tenant defaults on the special agreement, I’m only out one month.
• I will have a face-to-face meeting with the tenant to discuss any alternative ways he can get the money.  The point of this is obviously to get the money.  But the secondary point is to impress on the tenant just how serious a matter this is.  “You can’t pay me $600 in rent, but you just bought a $800 TV?  Sell the TV or return it.”  This meeting should be at the tenant’s unit.
• I won’t offer a temporary agreement until the end of our face-to-face meeting. That meeting is my last chance to consider the tenant before I offer an agreement - and if I get a strong ssense that he’s not being serious, out he goes.

If the tenant violates the agreement, I will evict him – hard and fast.  I will make this very clear at our face-to-face meeting and follow up if he violates the agreement.

The written agreement will have a confidentiality clause.  My tenant talk to each other, and I simply can’t afford to have John tell Carol, “The landlord gave me a break.”

Do I have to treat everybody the same?

No, thank goodness.  I can treat people differently, within reason.  I can, for example, come down much harder on a tenant who has behaved badly in the past, or who has a history of late payments.  Searching the Internet, I was unable to find a successful lawsuit in a case where a landlord made a special deal for one tenant, but not for another.  That doesn’t mean such lawsuits don’t happen, but they are rare enough to not be a major concern.

Next week I’ll dig more into this, looking into some different “can’t-pay” situations and how they should be handled.

Tags: Economy, Landlord Tenant, real estate

When people first decide to buy an apartment building it is common for them to make a few easily preventable mistakes. The most common error that I see new investors make is not having what I like to refer to as the “investor tool chest”.

For example, if you wanted to build a house you would need a few things to get started. You would need first to have a blue print for the home drawn up by an architect. Second, you would need to have the proper tools to actually complete the building, You would need the nails, hammers, saws and drills to work on the raw materials. Thankfully, investing in apartment buildings doesn’t require any physical tools or skills. However, investing in apartment building does require the same kind of mental planning and in this case your “tool chest” is actually a “tool chest” of knowledge.

To Be a Successful Apartment Investor, You Must Have a Plan!

The best way to acquire these essential educational tools is to read many books and magazines on the subject. The first and most important tool that an investor can have is the ability to determine the investment value of apartment building. There is no way that an investor can be sure that he or she will be buying a cash cow or a money pit without the necessary ability to analyze the value of a building. There is an endless array of information available about debt coverage ratios, cap rates and real estate evaluation. In my opinion the first time commercial real estate investor should operate with one simple mental “tool” or presumption and that is to determine what the building is worth to him or her and to ignore almost everything else. What this means is that investor should virtually ignore what prices other similar properties have recently sold for in the area. Instead, the investor should figure out the price that will allow him or her to buy the property and make the profit and cash flow that will make it a good investment.

In order the figure out what price you should pay for an apartment building, assuming for example that you want to realize a certain return, or Cap Rate on your investment annually, simply use the following formula:

Net Operating Income
__________________ = Price You Can Pay to Realize a Desired Cap Rate
Capitalization Rate

Photo Credit: jthetzel

Tags: apartment building course, apartment building education, apartment building investment, apartment building news, buy apartment building, buy apartments

Here is the third and last installment of “Questions to Ask Your Property Manager.” I am providing answers to some of the questions. However, in some cases, there is no one “right” answer. Actually, this was illustrated by the last installment, published three weeks ago. I had suggested that it is better for property managers to have some of their own skin in the game, so to speak, by owning their own rental properties in the area. Josh Dorkin, the founder of BiggerPockets, disagreed.

My underlying point: Lots of property managers don’t really understand the business, and go into rental management because they think it will be easy. Managers who own their own properties are more likely to have a clue about property management.

Josh’s underlying point: Property managers who own their own rentals are more likely to take care of their own properties first and consider you a competitor, especially when it comes to finding tenants. For example, they’ve got a vacant two-bedroom unit and you’ve got a vacant two-bedroom unit. When a prospect comes in looking for a two-bedroom, the managers will push their unit first.

Who’s right? We both are on the underlying points. So do you want your property manager to have his own rentals? That, my friends, is a judgment call. But consider this – if you don’t ask the question, you’ll never know. You won’t really be able to make an informed decision.

The best time to ask these questions is, of course, before you hire a management company. But if you already employ a management company, and don’t know the answers, you can always go back and ask. Besides knowing what’s going on with your property manager, you’ll be reminding them that you are an involved customer. That might make them less likely to cut corners with your properties.

The first and second parts of this series are linked here and here.

On to the Property Manager Questions (and, sometimes, Answers)

• Question: What do you consider the most promising towns and parts of the area for investment?
• Question: Where do you see rents going? What has been the development in rents over the last few years?
• Question: What towns and parts of the area have the best governmental climate?
• Question: What towns and parts of the area have the best business climate?
• Question: What kinds of people are attracted to this area? That one?
• Question: What kind of new inventory is coming on the market?
• Question: What’s going on with commercial development in the area?
• Question: Which towns have the best schools?

Answers: These are “no one right answer” questions. But that doesn’t mean the answers won’t be revealing! Consider all the different ways they can be used.

• The answers need to be thoughtful and detailed. Seriously, do you really want a property manager who doesn’t know which are the hottest parts of town?
• The answers can be very helpful in helping you decide where to invest. This is especially useful if you are not a resident of the area.
• If you do some research ahead of time, you’ll have your own ideas which you can compare to the answers you get from the prospective property manager. You might hear what he says and think “that’s completely wrong.” Or he might convince you, and now you’ve learned something new.

Tags: find property manager, interviewing managers, landlord, property management, property-manager, renter, tenant