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Rick R.
  • Richardson, TX
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Commercial Retail - Big box store Out of State

Rick R.
  • Richardson, TX
Posted Jan 24 2023, 20:40

Hello Investors

I need some advice on this out of state Commercial purchase. We own small Commercial office spaces and are looking into purchasing a Retail building with 2 tenants with one of them being a big box corporate tenant which sells furniture and another a local restaurant. Big box tenant occupies 80% space and has been at this location for about 4+ years. This is managed by a Property management company

Purchase price is $7.3mil at 7.15% cap, NOI = 522K, NNN leases and both have 5+ years lease on their primary lease term with 3x 5-year options to renew. We will be financing this with 25% to 30% down at about 7% interest rate. With the current rents it works about about 7%-8% Cash on cash returns with Principal loan payment + cash flow. Our cash flow will increase if interest rates go down in next few years.

1) Any input on this deal? Our biggest concern is what happens if the Big box tenant goes out of business. It can be challenge to replace them

2) What gotchas to look out in the Lease agreements?

3) Any creative loan options to go for a lower interest rate? 

Appreciate your advice

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John McKee#5 Commercial Real Estate Investing Contributor
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John McKee#5 Commercial Real Estate Investing Contributor
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Replied Jan 24 2023, 21:41

Hire a mortgage broker to shop this deal for you. Read the lease closely to make sure it's a NNN with no landlord surprises like your responsible for the pylon sign, parking lot, HVAC, or roof replacement. Yes it can be a challenge to replace the big box store because of the size. You might need to eventually subdivide that large space into smaller units. I'm not sure how you can finance this with a 7% interest rate and a 7.15 cap and only 25% down.

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James Storey
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  • Indianapolis, IN
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James Storey
  • Real Estate Agent
  • Indianapolis, IN
Replied Jan 25 2023, 05:01

Location is everything for big box tenants. I would look more into the demographic trends in the immediate area since this is how retail tenants chose their locations. We track all of the tenants requirements that way we can chose our replacements if a tenant decides to move. 

I would also hire a mortgage broker on this deal to see if they can get you a better rate. We were just quotes something in the low 6% range from one of our brokers. Might be worth you looking into.

regarding the lease, just make sure it is a true NNN lease and not have a bunch of landlord responsibilities. I would also look more into the condition of the building because you don't want the tenants to dangle large capital improvements in front of you before their lease renewals.

James Storey, CCIM

  • Real Estate Agent Indiana (#RB17001849)

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Drew Sygit#2 Managing Your Property Contributor
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Drew Sygit#2 Managing Your Property Contributor
  • Property Manager
  • Royal Oak, MI
Replied Jan 25 2023, 10:25

@Rick R.

We think the Midwest is a GREAT place for OOS investors to consider!

YES, we may be a little biased, but check out our blog here on BP comparing Detroit to other cities and Deep Dives on Metro Detroit cities & neighborhoods:

https://www.biggerpockets.com/...

(BP search feature can be problematic, so we’ve also added links @ our website under View Cities & Neighborhoods We Service)

Your biggest question shouldn't be WHERE to invest, but HOW you will invest!

Many OOS investors set themselves up for failure because they don't truly take the time to understand:

1) The Class of the NEIGHBORHOOD they are buying in - which is relative to the overall area.

2) The Class of the PROPERTY they are buying - which is relative to the overall area.

3) The Class of the TENANT POOL the Neighborhood & Property will attract - which is relative to the overall area.

4) The Class of the CONTRACTORS that will work on their Property, given the Neighborhood location - which is relative to the overall area.

5) The Class of the PROPERTY MANAGEMENT COMPANIES (PMC) that will manage their Property, given the Neighborhood location and the Tenants it will attract - which is relative to the overall area.

6) That a Class X NEIGHBORHOOD will have mostly Class X PROPERTIES, which will only attract Class X TENANTS, CONTRACTORS AND PMCs and deliver Class X RESULTS.

7) That OOS property Class rankings are often different than the Class ranking of the local market they live.

8) Class A is relatively easy to manage, can even be DIY remote managed from another state. Can usually allot 5-10% vacancy factor and same for maintenance.

9) Class B usually also okay, but needs more attention from owner and/or PMC. Vacancy and maintenance factors should be higher than for Class A as homes will be older, have more deferred maintenance and tenants will be harder on them.

10) Class C can be relatively successful with a great PMC (do NOT hire the cheapest!), but very difficult to DIY remote manage. Vacancy and maintenance factors should be higher than for Class A or B. Homes will have even more deferred maintenance and tenants will be even harder on them.

11) Class D pretty much requires an OWNER to be on location and at the property 3-4 times/week. Most quality PMCs will not manage these properties as they understand most owners won’t pay them enough for the time required and even then it’s too difficult successfully manage them.
***Only exception is if an owner has plan & funds to reposition Class D to Class C or higher.

https://www.biggerpockets.com/forums/776/topics/960183-what-they-dont-tell-you-about-cheap-rental-properties?highlight_post=5562799&page=3#p5562799

Also, SERIOUSLY consider - do you really have the time to be a DIY landlord or should you hire a PMC?

Good luck with whatever you decide😊

Please send us any feedback via email, as we do not use the DM feature here.

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Joe Miller
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Joe Miller
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  • Columbus, OH
Replied Jan 25 2023, 13:15

1.) Is the tenant publicly traded? If not, I would want to see their past 3-years of financial statements. You can also ask if anyone in their brokerage offers underwriting services for the tenant financials. How does their current lease compare to the surrounding market? I would want to know if the property is underrated, overrated, or at market rate. Finally, I would evaluate the demand for retail space of the same square footage in that market: what is the vacancy rate, 12 mo net absorption, and SF under constructions. Call local brokers with lots of tenant rep experience to get their opinion on how long it would take to refill the space and any challenges you may overlook.

2.) The biggest question is what are the annual increase (if any) in the lease and how fast can you climb into a higher cap rate? This becomes very important in an inflationary market. 3% increase are ideal at a 7.15 cap with a local tenant occupying 20% of the space. 

3.) I would speak with a lender. 

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Michael K Gallagher#3 Commercial Real Estate Investing Contributor
  • Real Estate Agent
  • Columbus OH
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Michael K Gallagher#3 Commercial Real Estate Investing Contributor
  • Real Estate Agent
  • Columbus OH
Replied Jan 25 2023, 14:38

@Rick R.

1) regarding what to look for in the lease, I'm normally on the tenant rep side negotiating for the tenant so I'll tell you what I usually try and get into my deals....We try and make sure that if the tenants are responsible for HVAC, or other major systems, that we limit those exposures to the prorata share of the usable life the tenant will be using.   I also usually try to add language that if the main tenant or anchor tenant of the center leaves or goes dark or fails to operate that the other tenants can up and leave.  

2) Regarding what to do with the space if and when they leave...There are the obvious solutions of demising the space and adding additional smaller tenants.  But Market and what else is in that retail corridor is really what will determine the desirability or the location for future tenants.  There's always the play of self storage conversion, or perhaps a craft brewery/tasting room would have a use for such a large space.  

Just some thoughts. 

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Michael K Gallagher#3 Commercial Real Estate Investing Contributor
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Michael K Gallagher#3 Commercial Real Estate Investing Contributor
  • Real Estate Agent
  • Columbus OH
Replied Jan 25 2023, 14:41
Quote from @Joe Miller:

1.) Is the tenant publicly traded? If not, I would want to see their past 3-years of financial statements. You can also ask if anyone in their brokerage offers underwriting services for the tenant financials. How does their current lease compare to the surrounding market? I would want to know if the property is underrated, overrated, or at market rate. Finally, I would evaluate the demand for retail space of the same square footage in that market: what is the vacancy rate, 12 mo net absorption, and SF under constructions. Call local brokers with lots of tenant rep experience to get their opinion on how long it would take to refill the space and any challenges you may overlook.

2.) The biggest question is what are the annual increase (if any) in the lease and how fast can you climb into a higher cap rate? This becomes very important in an inflationary market. 3% increase are ideal at a 7.15 cap with a local tenant occupying 20% of the space. 

3.) I would speak with a lender. 


 the point about increases is a great one.  as is reaching out to a local tenant rep broker.  They will give you an honest opinion on how they'd pitch the space to a client.  

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Ronald Rohde
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Ronald Rohde
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Replied Jan 25 2023, 14:55

As noted, is there demand for the location? Its your job to carve it up and price it right, but you've got to have demand first. My clients do a lot of retail, if you don't want it, would you post the information?

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Rick R.
  • Richardson, TX
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Rick R.
  • Richardson, TX
Replied Jan 26 2023, 06:06

Thank you all for your prompt responses. Here are more details on the deal

Purchase price : $7.3mil, 7.15 cap, NOI = 522K, NNN leases (landlord responsible for Structure, roof only)

Loan : 30% down, 7% fixed for 5-years and 25-year term, Annual P+I = $435KK, ROI = $88K

Rent escalations during after primary lease term at 8% every 5-years

Big box tenant is publicly traded company are doing fine in this market

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John McKee#5 Commercial Real Estate Investing Contributor
  • Investor
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John McKee#5 Commercial Real Estate Investing Contributor
  • Investor
  • Fairfax, VA
Replied Jan 26 2023, 15:48

Your return on your investment is actually 4.01%  (88,000/2,190,000).  For this size loan I would shop it around as I think you can do better than 7%.  

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Joel Owens
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Joel Owens
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ModeratorReplied Feb 26 2023, 08:13

A 7% interest rate and a 7.15 cap rate DOES NOT equal a 7 to 8% cash on cash return.

With principal paydown for return on equity and total return then maybe if interest only or other type exotic loan.

A lender is going to have certain DSCR ratios and with 15 basis points between debt and cap rate you aren't getting in with 25 to 30% down.

I do not know who you are talking too. Please get with someone that knows what they are doing in this space before you lose most or all of your money buying a lemon.

Furniture stores are notorious for going out business. I would not touch the investment unless I knew they were paying like 2 bucks a foot and I could get 10 bucks a foot with another tenant. The roof, parking lot, mechanicals could run into the millions in cost against your expected cash flow with heavy capex.

Have no clue why you would go for this. You are likely much better off buying a STNL tenant absolute NNN with credit grade for 7 million putting 35% down with loan in the 5's for rate and 25 to 30 year amortization with cap rate high 6's.

That big retail box likely has co-tenant clause where if they go dark and not-re-tenanted in 6 months or less than other tenants can reduce rent 50% or vacate lease all together and move.

Again if you do not know an expert in this space please find one to protect your capital. People often look at 4 caps with multifamily and see a 7 cap retail center knowing nothing about the business how to underwrite these and get sucked in. Sellers with the listing brokers LOVE these buyers because they can sell them the trash. Just because a lender will give you a loan on something doesn't make it a great property.

Good luck

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Replied Feb 26 2023, 16:54

In Retail Commercial why is there a need for property management if the leases are NNN?

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John McKee#5 Commercial Real Estate Investing Contributor
  • Investor
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John McKee#5 Commercial Real Estate Investing Contributor
  • Investor
  • Fairfax, VA
Replied Feb 26 2023, 20:07

There is no need for a property manager if it's a single tenant net lease.  Sometimes there can be a property manger if it's a shopping center with dozens of tenants as there are more common areas and tenant issues.  

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Kent Parks
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Kent Parks
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Replied Feb 27 2023, 01:43

Some of you have mentioned the word underwriting. Just so I am clear, do you mean due diligence or are you referring to the way you structure the lease terms? 

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Ronald Rohde
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Ronald Rohde
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Replied Feb 27 2023, 07:22
Quote from @Alex Skeg:

In Retail Commercial why is there a need for property management if the leases are NNN?


Have you ever owned NNN? There is still accounting, LL obligations, tenant questions, lease questions, late notices, loan reporting, etc. Its easy to self manage, but plenty of work for third party as well. Also depends if single tenant or multi tenant.

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Ronald Rohde
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Ronald Rohde
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Replied Feb 27 2023, 07:24
Quote from @Kent Parks:

Some of you have mentioned the word underwriting. Just so I am clear, do you mean due diligence or are you referring to the way you structure the lease terms? 


 So underwriting typically refers to the complete spectrum of analysis including whether to close on a property on closing day. Due diligence review is just a subset of underwriting, similar to how modeling is just one part of underwriting. Lease terms would be underwriting as you model future vacancy or renewals. 

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Kent Parks
  • Rental Property Investor
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Kent Parks
  • Rental Property Investor
  • Birmingham Alabama
Replied Feb 27 2023, 08:14
Quote from @Ronald Rohde:
Quote from @Kent Parks:

Some of you have mentioned the word underwriting. Just so I am clear, do you mean due diligence or are you referring to the way you structure the lease terms? 


 So underwriting typically refers to the complete spectrum of analysis including whether to close on a property on closing day. Due diligence review is just a subset of underwriting, similar to how modeling is just one part of underwriting. Lease terms would be underwriting as you model future vacancy or renewals. 


 When you say model, I take that to mean forcasting. Would I be correct?

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Will B.
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Will B.
  • Real Estate Broker
  • Louisville, KY
Replied Feb 27 2023, 14:04

Much answered by others here. I'll add if the furniture tenant just leaves, that depends on the lease agreement provisions. Read it not just an abstract, there maybe a go 'dark provision' that permit tenant to ditch the space before lease expiration if they don't turn a profit and that might affect a provision in the other tenant's lease. But that provision might such they continue rent payments or a number of different scenarios. There's a number of provisions which address situations like go dim, landlord recapture, percentages lease, financial reportings see "kick clause". There's too much here I can't include in a few min.  It would def be worthwhile to work with a attorney with commercial lease experience to review it. Having access to  retail broker, like a good one is critical too.  

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Courtney Nguyen
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Courtney Nguyen
  • Spring, TX
Replied Feb 27 2023, 15:20
Quote from @Will B.:

Much answered by others here. I'll add if the furniture tenant just leaves, that depends on the lease agreement provisions. Read it not just an abstract, there maybe a go 'dark provision' that permit tenant to ditch the space before lease expiration if they don't turn a profit and that might affect a provision in the other tenant's lease. But that provision might such they continue rent payments or a number of different scenarios. There's a number of provisions which address situations like go dim, landlord recapture, percentages lease, financial reportings see "kick clause". There's too much here I can't include in a few min.  It would def be worthwhile to work with a attorney with commercial lease experience to review it. Having access to  retail broker, like a good one is critical too.  

 Hi Will,

On financial reporting:  how will you enforce that (if you already have that clause in the lease that requires them to report their financial quarterly)?  Do we really need to put in lease that if they don't report their financial then there will be penalties?  Or you only care about getting reports from them if they have issues with paying rent?

Thanks.

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Joel Owens
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Joel Owens
  • Real Estate Broker
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ModeratorReplied Feb 27 2023, 15:28

If tenant is credit investment grade BBB- or better than Standard and Poor's is analyzing them constantly for debt load obligations versus liquidity on the balance sheet to see how healthy they are.

Also even if not in lease sometimes with stock reporting you can get the financials you need.

Tenants do not like reporting too frequently as it can increase their bookkeeping hours expenses.

If tenant is not investment grade I want everything I can get on them to constantly monitor the health of the business. I would want to see a downtrend way in advance to go ahead and get feelers out to lease the space than being blindsided with rent reduction request etc.

If they request something not required of the landlord in the lease the landlord can also request back in return to modify items they do not like. The question becomes does the landlord get equal or more value amending the lease than what they are giving up? If the answer is no they might want to replace the tenant.  

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Courtney Nguyen
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Courtney Nguyen
  • Spring, TX
Replied Feb 27 2023, 15:36

@Joel Owens thanks for the info.  Haven't seen you here for a while.  Glad to see you back.  Still reading your book.  Wish we had it when we acquired the property back then.

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Joel Owens
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Joel Owens
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ModeratorReplied Feb 27 2023, 16:07

Thanks Courtney. I stay really busy these days. Have to plan out everyday with calls and clients buying properties and myself buying my own. I check in here every so often when time allows.

The book I just finished last year. By next year I likely put out and expanded and updated version.

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Will B.
  • Real Estate Broker
  • Louisville, KY
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Will B.
  • Real Estate Broker
  • Louisville, KY
Replied Feb 27 2023, 17:55
Quote from @Courtney Nguyen:
Quote from @Will B.:

Much answered by others here. I'll add if the furniture tenant just leaves, that depends on the lease agreement provisions. Read it not just an abstract, there maybe a go 'dark provision' that permit tenant to ditch the space before lease expiration if they don't turn a profit and that might affect a provision in the other tenant's lease. But that provision might such they continue rent payments or a number of different scenarios. There's a number of provisions which address situations like go dim, landlord recapture, percentages lease, financial reportings see "kick clause". There's too much here I can't include in a few min.  It would def be worthwhile to work with a attorney with commercial lease experience to review it. Having access to  retail broker, like a good one is critical too.  

 Hi Will,

On financial reporting:  how will you enforce that (if you already have that clause in the lease that requires them to report their financial quarterly)?  Do we really need to put in lease that if they don't report their financial then there will be penalties?  Or you only care about getting reports from them if they have issues with paying rent?

Thanks.

(btw -forgive my previous typos, meant to say 'kick out clause')

If I understand you correctly, both spaces are performing with tenants, a restaurant and furniture store, right? First, you ask how does a landlord enforce the lease? If the tenants fails to abide by the lease terms then the're in breach so your legal counsel, pm, owner group or whoever could mail them a breach letter with the terms of the agreement. Having a strong handle on lease administration is critical.  

Second, you ask if wrote: Do we really need to put in lease that if they don't report their financial then there will be penalties? Or you only care about getting reports from them if they have issues with paying rent? If there's a current and bonafide lease agreement in force then the landlord and tenant must comply with the lease terms, I don't think you can insert language or "put in the lease" without a mutual consent to an addendum or amendment. If it ain't in the four corners of the lease, it ain't real, is my thoughts. If you want financial reporting from the tenant, then there must be a provision with specific language. Yes, we have provisions in some of our retail lease agreements that requires monthly financial reporting and lease provisions if the numbers aren't according to the agreed upon threshold, the LL has the right to terminate the lease. The idea being that it provides the LL ample time to find a replacement and avoid an long@ss vacancy. Procuring new qualified and suitable tenants requires months sometimes, upwards of a year.

  Seek an experienced lawyer on the matter, no legal advice herein.  






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Ronald Rohde
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Ronald Rohde
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Replied Feb 28 2023, 07:00
Quote from @Kent Parks:
Quote from @Ronald Rohde:
Quote from @Kent Parks:

Some of you have mentioned the word underwriting. Just so I am clear, do you mean due diligence or are you referring to the way you structure the lease terms? 


 So underwriting typically refers to the complete spectrum of analysis including whether to close on a property on closing day. Due diligence review is just a subset of underwriting, similar to how modeling is just one part of underwriting. Lease terms would be underwriting as you model future vacancy or renewals. 


 When you say model, I take that to mean forcasting. Would I be correct?


 The model can also include current valuation metrics. Its just a spreadsheet with income and expenses, valuation calculations. If you're trying to refer to DCF models, thats slightly different.

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Kevin Sellers
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Kevin Sellers
  • Lender
  • Charleston, SC MSA
Replied Mar 1 2023, 08:55

Don't know where you are getting your financing but the loan terms are poor.  I am a commercial mortgage broker arranging financing for single tenant and multitenant properties nationwide.  My lenders are offering interest rates from 5.50% to 6.50% fixed for 5, 7 or 10 years on 25-30 year amortization schedules depending upon the tenant(s), remaining lease term(s), property location and buyer's financial strength.  Local banks will sometimes provide higher leverage but other loan terms are not competitive. The furniture store is a public company but is it rated BBB- or higher by S&P or and/or the equivalent rating by Moody's?  That makes a big difference to a lot of lenders.

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Kent Parks
  • Rental Property Investor
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Kent Parks
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Replied Mar 6 2023, 04:06
Quote from @Ronald Rohde:
Quote from @Kent Parks:
Quote from @Ronald Rohde:
Quote from @Kent Parks:

Some of you have mentioned the word underwriting. Just so I am clear, do you mean due diligence or are you referring to the way you structure the lease terms? 


 So underwriting typically refers to the complete spectrum of analysis including whether to close on a property on closing day. Due diligence review is just a subset of underwriting, similar to how modeling is just one part of underwriting. Lease terms would be underwriting as you model future vacancy or renewals. 


 When you say model, I take that to mean forcasting. Would I be correct?


 The model can also include current valuation metrics. Its just a spreadsheet with income and expenses, valuation calculations. If you're trying to refer to DCF models, thats slightly different.


 Thanks for your response.