Irrational pricing

17 Replies

I have been looking for a strip mall/ shopping center in my area and am not finding any below $3M that are priced based on cap rates or any obvious rational calculation. Also, at their asking prices, they would not have close to the lenders' required DSCR of 1.25 at 80% ltv. Who do they think will purchase these and why are commercial agents taking these listings? I've made two offers and even showed them my calculations (thank you Frank Gallinelli for your book!). Sellers were insulted. Also, it seems the only ones for sale have high vacancy but are pricing as if fully occupied.

As a residential real estate agent I often encounter irrational sellers (which is why I hate it and am going to start turning away clients), but didn't think I'd see it as much in commercial! Am I approaching this the wrong way? I have been looking on Loopnet ( with the free membership - Is it worth the extra $$ to upgrade?) New England Property Exchange (they also have some I can't access) and the MLS. I'm looking to purchase for around $1M, unless I can get better than 80% LTV. Since I'm a licensed broker, I want to represent myself as a buyer and use the commission for necessary upgrades. Thanks!

Originally posted by @Amy A. :
I have been looking for a strip mall/ shopping center in my area and am not finding any below $3M that are priced based on cap rates or any obvious rational calculation. Also, at their asking prices, they would not have close to the lenders' required DSCR of 1.25 at 80% ltv. Who do they think will purchase these and why are commercial agents taking these listings? I've made two offers and even showed them my calculations (thank you Frank Gallinelli for your book!). Sellers were insulted. Also, it seems the only ones for sale have high vacancy but are pricing as if fully occupied.

As a residential real estate agent I often encounter irrational sellers (which is why I hate it and am going to start turning away clients), but didn't think I'd see it as much in commercial! Am I approaching this the wrong way? I have been looking on Loopnet ( with the free membership - Is it worth the extra $ to upgrade?) New England Property Exchange (they also have some I can't access) and the MLS. I'm looking to purchase for around $1M, unless I can get better than 80% LTV. Since I'm a licensed broker, I want to represent myself as a buyer and use the commission for necessary upgrades. Thanks!

Why not ask the listing agent how the value was computed? When you asked who do they think will purchase their properties did you listen to their answer? What'd they say?

@Amy Arata You're very welcome ;)

Amy Arata

More than likely you will not be able to obtain financing at 80%LTV even if you made debt service. Financing for that product type and size will look more like 65-70 LTV unless you have a really good relationship with a local bank. You can also structure in a small seller carry back if the primary lender will allow it however they will still add this into the DSCR. Areas with low caps/high values will generally require more down to make debt service. Have you networked with all the brokers in this space? A lot of deals in that space are not listed however it would still be worth the money to pay for loopnet. Network network network!

As Chris mentioned, loans won't usually be at 80% LTV, the LTV is just a starting point as well in commercial. I don't know what was in your book, but at 1M and up there are other valuation considerations with taxes, depreciation effects that benefit higher income earners, after tax income and lease valuations are accomplished at a different level than residential units.

Using residential valuation methods alone in commercial, I can see where that could insult a more sophisticated seller. :)

Definitely pay for a membership on Loopnet. There aren't many good deals on Loopnet, but with the free look you're definitely seeing just the garbage.

You might consider building a list of properties that meet your criteria and market to the owners. Do this even if they aren't on the market. Send them a letter and call if your list isn't too big. You can hire a contract telemarketer if it's a bigger list. That would be for screening only. You'd talk to the real prospects personally. You may find someone motivated who is ready to sell now. Worst case scenario is you learn a lot more about your market.

Another thought. Commercial cap rates have compressed substantially over the past 2 years or so. You might consider waiting it out for the next down cycle to buy when prices make sense again. Find a liquid investment vehicle in the mean time. Possibly lending or notes.

@Amy Arata

I had the free loopnet membership however there are ways to run the queries where you see most of the data that you need to see. Most data has full description with the exception of price. If you sort the data you can have a vague idea of what price bracket the property you are interested in is, without the need to upgrade. I would like to think I picked a good deal from loopnet as it has appreciated significantly in under 2 years. You can also consider commercial properties which are up for lease and asking whether the owners would consider selling lastly just making a note of empty commercial buildings and finding the owners and making an offer on them.

@Amy A.

We are experiencing similar irrationality here just to your north. We have the highest commercial vacancy rate I can recall - 15-18%, yet sellers are asking prices which provide CAP rates of 4-6% and the lenders will not entertain LTV

I concur with Jon, something has to give here and the best strategy is probably waiting until it does.

What you are writing is very timely for where I am in my business.

It is possible the sellers are trying to pass their same mistake on to you. Also, some commercial brokers do not know income approach. They just sort of "comp" value the listing. They are looking for someone who does not know as much as you. And may find them. Can be frustrating.

Yes, loopnet premium will give you more listings and I upgraded a few months ago. You can pay for recent sales individually or via subscription which might help you to gauge the reality on the street.

Also, I think when starting in a new arena you dont get the same deals as veterans so you just might have to accept non stellar deals when starting out. After you have made some offers and then closed you'll find brokers calling you first. I think many of the deals happen this way.

Good luck. You'll get there.

@Bill Gulley are buyers willing to take negative cash flow just to get a tax deduction, with depreciation that will have to be reclaimed later anyway?

I think the problem is that I'm using strictly commercial valuation methods, based on NOI, not on construction costs or comps as in residential. I just spoke to a commercial broker who said that many sellers seem to think a buyer will show up with all cash (Mainers often think a rich fool from Mass will show up with cash and overpay - I'd like to find this mythological creature). They don't take into account the fact that most buyers need a loan. Even if I had $1M to spend, I wouldn't put it all in one property.

I have a good relationship with a local bank, but it's true they may now want 75% LTV. I closed about $400k in commercial residential loans with them last year. My fear is that they may think they have too much risk exposure to me. Also, my husband left his job and started his own business, which may become an issue for them (savings from apartments and "flips" allowed him freedom to leave the corporate world).

I often see commercial loans advertised at 90% LTV, are these just teasers?

Thanks everybody!

If you see a commercial loan at 90% LTV then ask if there are ANY fees prior to closing?? Usually that's when all the BS starts.

I haven't seen 90% in years and years. When properties were more depressed and way undervalued some lenders would go 90%. The LTV is just one component and you have to look at interest rate (fixed or floating, term to loan being called, amort. schedule, any recourse or personal guarantee, any cross collateral requested, any pre-pay penalty, can the loan be assumed to qualified purchase down the road, upfront costs to close the loan, qualifying standards for this type of loan, etc.)

Amy the owners you are talking too sound non-motivated. They are doing what we call (testing the market) to see if any over-motivated buyers out there who will pay a premium. The sellers are comfortable with the cash flow and do not NEED to sell.

I don't care what niche of real estate people focus on for investing or as a broker/agent to transact there is always competition. I look through sometimes hundreds of properties a day, makes calls to sellers directly, mail out for off market stuff, call other brokers (sometimes they have been talking off market to an owner for a few months and the owner is finally ready to do something).

For small retail strip centers the newly minted corporate tenant ones I am seeing with strong lease guarantees are going from 6.5% to 7.5% cap rates. As the mix say on a an 8 unit retail strip moves in mix the cap increases. So a 8/8 in the 6 to 7 plus range, 6/8 ( 6 corp,2 mom and pop) it goes up 50 or more basis points etc.

The location plays a factor as well. If you have mainly mom and pop but location is very good with growth happening all around then you will see a lower cap.

When evaluating retail strips for my clients I have to see total sales per store in the complex. If it's a corp guarantee spread out amongst a lot of stores there is less risk. If it's a mom and pop you want the lease no more than ideally 8% of gross sales and 12% is pushing it. So if one tenant had 200,000 in gross sales the lease would be ideal at 16,000 or less a year. Now there are other considerations such as gross profit margins on the concept they have. Some businesses have high sales but low margins so you have to dig down further.

I prefer DESTINATION businesses. Places where consumers HAVE to go for the experience versus things where they can " look and book " and go home and buy online for cheaper. Dry cleaning, restaurants, hair cuts, doctors office, etc. are examples of where people have to go to get something done. The more impulse type tenants the area has to have a lot of high disposable median income.

The depreciation goes away in a stepped up basis when they pass away. This is why buyers keep purchasing more property to keep taking more depreciation.

Sometimes commercial buyers are offsetting gains from other properties or are using pay down re-advance features. The more money you make the more the government wants to take. This is why wealthy people have teams of people constantly working strategies to make them look poor on paper. As the money increases usually the complexities and planning go up. A wealthy investor might pay a lower cap for quality with an exchange versus someone starting out who needs a high return to jump off of.

Here is an interesting article that gives a few examples.

PAY DOWN RE ADVANCE

90% SBA owner occupied, there are also economic development loans that may be available. SBA won't be for residential units, ED loans can be.

Yes, I'm considering doing a deal on a commercial row that won't cash flow. We'd be changing use from old flea market types to restaurant, bars, coffee shops where the area will be changing.

Yes, taxes are certainly considered, appreciation, forcing value through management and rehab, changing uses and areas as just mentioned. A seller can be aware of changes in an area for example. Expected rents can be considered, so it's not always the track record of income to value property.

Taxes also depend on what the tax plan is, around 7 to 9 years it begins to diminish, you can then go with a 1031 exchange and keep going.

Yes, valuations are primarily from cash flow, not considering other aspects is a mistake. An appraiser (MAI) may comment in the narrative appraisal of other aspects, if 1. they can show that aspect in the market and 2. there is a measurable financial basis to compute effects. Only you can assess value to you, all others only provide opinions.

Yes, self employed status can be an issue if he is working outside the area of his previous employment, it may not be if he's in the same or similar line of work and then there is the taxable income.

Sounds great having built a good relationship at the bank!!!!

for a 1M investment, $60 is nothing

"I have been looking on Loopnet ( with the free membership - Is it worth the extra $$ to upgrade?) New"

I just joined Loopnet yesterday! Frankly, I'm not finding that much more info than I had access to before. However, if I consider the fact that it's a tax deductible expense, it's not too expensive. I guess I'm just spoiled by my free MLS access.

@Amy A.

Your area might not have a lot of listed property. My buddy's family owns a house in Boothbay Harbor Maine that we vacationed at every 4th of July (love it up there). My feeling of most of Maine is that it's a lot of small towns and small networks. I would think the real estate community is really small especially in a niche of commercial real estate. Maybe I am completely off base however your best bet might be to network network network. Good luck!

Amy you need to mine that counties tax assessor database for commercial property owners.

You will find some after awhile have multiple holdings there. It will be more difficult to locate the owners. Sometimes the tax records list a trust, limited partnership, llc, etc. You have to dig to find these people but it can be worth it to connect because other people have a hard time finding them as well.

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