Multi Tenant Strip Malls (Retail) Owner Financing Deal Thoughts

21 Replies

I have been discussing possible opportunities with a retiring commercial real estate investor and developer in the Kansas City, MO area.  He now lives out of state.  I have met with him four times to go over the deals and opportunities with him.  He owns his properties free and clear and wants to sell them to me on an owner financed note to avoid a huge tax hit.  Here is what a typical deal would look like:

25 years at WSJ rate +2% (Currently 5.25%)

i need about 200k ish to put down on each.  comes out to about 15% down.

Each property is in a very good location, retail, all rented, and cash-flowing with long term leases. All triple net leases.  Rent increases are at about 6% a year.

Net Income on the first one I would buy is 110k, he will sell at around a 7 cap.  In one year the net income (with rent increases) jumps to 130k, then about 6% a year after that. 

This same guy has also been mentoring me about commercial real estate.  I own 10 rental houses so haven't dived into commercial yet.  I feel like this is an opportunity that I shouldn't pass up. 

I could end buying quite a few properties from him this way.  These propertis are all in A and B locations in KC.

I am curious to here everyone's thought on these deals.  I am excited but also don't want to get burned.  I know the seller well and trust him.

If the numbers are right, sounds like a killer opportunity! If you don't want it, sharing is caring. haha

Updated about 3 years ago

7% for NNN is pretty good.

Why are you paying for a NOI at 7% cap in a 10% cap market?

10 cap NNN???? sounds unlikely

Originally posted by @Account Closed :

10 cap NNN???? sounds unlikely

7% cap NNN is more likely based on what?

Multi tenant strip malls a 7 cap is just OKAY.

A newly minted long term lease single NNN building is good for a 7 cap in this cycle.

Big difference between single NNN and multi NNN.

I also think you are confused about rents rising 6% a year on a retail lease. Multi-tenant strip centers 2% per year is normal. Where the confusion may be is some do not go up 2% a year but a tenant in the center that is national might go up in a 3 year block 6% at a time but it is still 2% a year.

A 5.25% to a 7% cap is only a 175 basis point spread between debt and purchase cap. That is not good for a strip center. My clients are buying 8 to 8.5 cap and debt at 4.5. So 350 to 400 basis point spread.

Would try to increase cap rate, increase amortization to 30, get interest rate lower to in the 4's. 15% down can be good versus 25% down. You can get 15% down but usually it's 75% ltv senior with 10% mezzanine debt that is at 10%.

Andrew do you have 200k to put down on each one??

I would have to underwrite each property and the leases among many other things. Sounds like to me he is being rich on the price to give you owner finance. You can't pay above market for owner finance. Owner finance deals can work if you are paying market or below sometimes and massaging the financing some with seller terms.

All cash usually you get a good discount or higher cap rate. 

Thank you all for the comments.  I have the same concerns, he is being rich on the cap rate i think as well.  The rents are currently all below market, I have reviewed his leases, they have rent bumps of 6% annually on each tenant.  Not 2%, it is more than 6% the first two years.  He does this I would imagine to get the tenants in there to build their space out with lower rent.  This particular property, along with all of his, are in top locations in Kansas City.  When reviewing the leases, the rent increase greatly increase the cap rate in two years.  He is selling to me at the lower "current" below market rents.  I want to pick them up for around an 8% cap with about 150-200k down.

I like the basis point spreads you provided Joel it will provide a negotiation tool.  Like that alot.

Things to note.  The rate isn't fixed for 25 years it adjusts (yearly i think) which is a concern.

Tenants in this building are not national tenants.  All small business's which I think has some risk to it.  However, it is has been fully rented for the past 10 years to my knowledge.  Great location.

I have already negotiated a delayed downpayment, where I pay half now, and in 24 months pay the balance of the downpayment.  I need to consolidate some rental houses since I dont have 200k cash, it is all tied up.

Capital is a concern at 200k per property.  i have a plan to aquire two however I will be stretched.  Figuring out an equity partner would help greatly, especially if I want to buy more of his properties.

Another concern I have is if I unload the same amount of capital into rental houses the cash on cash returns are better, much better.  So, I am trying to determine the "why" I would do this.  It is all new to me.  I feel like my appreciation on commercial will be substantially more but that isnt a reason to dive in.

Thanks again.

I sure would not do it with a variable rate unless the floor and ceiling were less that 1% of the current. No, I probably still wouldn't at the quoted rate, but those are merely a math problem for the decision. Are they truly NNN where you pass ALL expenses to the tenants (including exterior maintenance) or some modified version: N, NN, or other? If truly NNN, the CAM must be pretty stout.

It is 100% Triple Net Lease.  All expenses paid by tenants, including exterior maintenance.

I'd say a 6% increase is over the top and mom and pops can move. I see you're sold on the location, what's the traffic count, any comps? I know it's not down on the Plaza, that's A in KC.

Are you familiar with the tenant's business, type, industry ROI, market, what influence their income to pay higher rents, their ability to pay?

The note sounds fine, the value of the property is based on what it is today, not what it might be. 

Stress test, how many units can be vacant and still keep you above water? 

Any environmental concerns with any tenant, like a paint store or hobby shop, dry cleaners, pawn shop or print shop?

Is the NNN lease on common areas and outside equipment, like HVAC? How's the parking lot expense allocated? What repairs are needed?

How are leases secured with mom and pop, any assignments or receipts, inventory or sales? That 6% annual increase is high! Even mom and pop will find that out. 

I'd bet you need some more due diligence and I don't know how you can know someone "well" after meeting them 4 times. But, this could be a good deal, do your homework away from the seller. Good luck :)  

Bill, 

Thanks for the response.  All your concerns are items I am looking into as due diligence.  I don't see 6% as over the top.  Their 60 to 100 dollar increase annually is nothing compared to their investment on building their space out.  These companies have to much skin in the game already.  Their business decision to move out after spending 60k in tenant improvement does not seem likely.  Then spend the same on a new space.  Rents are already under market and the 6% increase is in the lease.  They signed up for it.  Again, that is my rookie opinion.  Could be wrong could be right, I dont know.  but I have confidence in the lease in hand.

No repairs needed, HVAC's all separate and tenants responsibility.  Each lease has the additional monthly fee's required for CAM, Management, Real estate tax/insurance all in addition to my previously stated Net Income totals. 

I defiently don't know him well, probably misspoke.  Our relationship started when he wanted me to work/partner with him on some development opportunities and or help with some of his projects (all which i still may do).  I believe he is looking out for my best interests.  I also think there is a lot of negotiation room on the financing and cap rate.

Property is located just north of plaza off main street.  Don't know the traffic count but it must be one of the highest in the city.  road is very busy.

Just to confirm you opinion.  You feel 25 years WSJ+2% is a good note.  Even if it adjust annually?

Things always looks good when you do not have the experience to see the reality of what is being offered.

I am telling you that I look at hundreds of properties a week for single NNN and multi NNN and my level of underwriting properties is a lot deeper than many buyers. A 6% increase per year is expensive and is not normal for this space. Developers try all kinds of wacky structures to run their agenda. The problem is a lender and the buyers will not view their structure the same way.

One typical strategy I see is a developer does TI build out for a tenant with free rent. Then they backload large rent increases or a higher than market rent per sq ft average to try and make it up faster. They hope rents rise by the time they sell. A lender will view this differently. They see a space at higher than market appraised rents and if that tenant goes dark the new tenant will only pay market rents. So the lender only counts market rent credit on the books and not the full value of the cash coming in the seller is showing.

Another one is a developer trying sell based on rent increases in the future and then saying they will pay the difference in escrow between existing rent today and the increases if the lender will count the numbers based on the new figures.

A mom and pop tenant you have to underwrite them in a different way then a national tenant. Rent increases on paper are theoretical and nothing more until they happen.  

Would not accept interest rates rising annually with the market. Rents could stay flat and you have vacancy or market rents could drop. In that situation your debt service keeps rising but your income goes down. You get squeezed from both ends.

Joel, 

Thanks for the insite.  I am meeting with him again to look at more of his buildings on Tuesday that he wants to sell.  Including this one.  We are also looking at his RV Park and storage unit projects.  The projects he wants me to help with.

Eitherway, i am going dig much deeper.

Joel, when he sends me the performance of these properties on paper I would love for you to take a look and let me know your thoughts.

Andrew glad to look at it and give you my thoughts just e-mail it to me. Documents are best viewable in .pdf format for leases etc. 

@AndrewT 

North of the plaza does have a ton of traffic however depending on location parking can be an issue.  I would look at that potential issue. I'm always willing to stop at office max, Starbucks, and quick trip because I can get on and off Main Street however not as willing to stop at some of the smaller businesses because of parking. If you are relying on foot traffic, keep in mind that KC is a city of cars. Unfortunately, at this time the public transport is used mostly by folks living in poverty  although hopefully some of that will change with the streetcar coming in the future and the bike rental system. Good luck!

Originally posted by Oliver T.:

Bill, 

Thanks for the response.  All your concerns are items I am looking into as due diligence.  I don't see 6% as over the top.  Their 60 to 100 dollar increase annually is nothing compared to their investment on building their space out.  These companies have to much skin in the game already.  Their business decision to move out after spending 60k in tenant improvement does not seem likely.  Then spend the same on a new space.  Rents are already under market and the 6% increase is in the lease.  They signed up for it.  Again, that is my rookie opinion.  Could be wrong could be right, I dont know.  but I have confidence in the lease in hand.

No repairs needed, HVAC's all separate and tenants responsibility.  Each lease has the additional monthly fee's required for CAM, Management, Real estate tax/insurance all in addition to my previously stated Net Income totals. 

I defiently don't know him well, probably misspoke.  Our relationship started when he wanted me to work/partner with him on some development opportunities and or help with some of his projects (all which i still may do).  I believe he is looking out for my best interests.  I also think there is a lot of negotiation room on the financing and cap rate.

Property is located just north of plaza off main street.  Don't know the traffic count but it must be one of the highest in the city.  road is very busy.

Just to confirm you opinion.  You feel 25 years WSJ+2% is a good note.  Even if it adjust annually?

 "I don't see 6% over the top".

If you were to buy this strip center the issue you may face in the not to distant future is that the "under market" rents are no longer under market, and in addition to tenants either being driven out of business because they can no longer pay the rent or just flat out move (and don't be fooled they will) you'll experience significant vacancies. 

If and when you might go to refi the property a lender will discount the rents to market, and or not refi based on the tenants financials making a refi difficult. 

I don't know CAP rates for your marketplace so I will reserve comment on that issue, but you should do some research as to what other strip malls similar to those in your marketplace have traded for recently. This isn't to difficult to ascertain if you have access to CoStar or know a commercial real estate broker in the local marketplace willing to share some comps with you.

The owner financing aspect to this proposed transaction is attractive, particularly the ability to leverage the down payment as you described. I would recommend you negotiate hard for the elimination of a prepayment penalty, or in the worst case a phased prepayment that reduces over time e.g. 6,5,4,3,2,1 or something similar (I did this in a commercial deal during the S&L crisis and used what the RTC used as their standard prepay).

Being able to get into a deal easy is terrific when its achievable, but you also want to ensure the economics of the property over the next several years will allow the project to remain economically viable.

6% annual rent increases are steep, particularly for mom and pop businesses. If I were sitting in your shoes I would underwrite the rental increases at current CPI (or historical CPI rates) to ensure you're covered. Its may not exist today, but yo will get blowback from the tenants moving forward with 6% rent increases.

All the best.   

Quick update. It's a 6 tenant NNN strip mall. Fully occupied Talked him to a 30 year note, 1% above WJS adjusted every two years. 10% down. All leases on personal guarantees. Receiving all leases and financials this week or early next week. Still wants to sell at 6.5% cap. I need to determine the cap rate that is acceptable. Thanks again all.
Quick update. It's a 6 tenant NNN strip mall. Fully occupied Talked him to a 30 year note, 1% above WJS adjusted every two years. 10% down. All leases on personal guarantees. Receiving all leases and financials this week or early next week. Still wants to sell at 6.5% cap. I need to determine the cap rate that is acceptable. Rent increases are 3%. The 5% plus was for the first two years in two different tenants. Thanks again all.

Andrew,

What ended up happening?. Did you make the purchase?

Best

Originally posted by @Andrew T.:

   When reviewing the leases, the rent increase greatly increase the cap rate in two years.  He is selling to me at the lower "current" below market rents.  I want to pick them up for around an 8% cap with about 150-200k down.

I

Andrew,  you can increase your rents and decrease your expenses but you have no control of the cap rates (well except when you plunk your money down and create and unanalyzed crap rate).  Cap rates are set by the market.  Everyone here commenting on whether it's 7% or 10% or what ever are just making wild *** guesses. 

Even if you increase your rents over two years the market might trade the NOI of your property type at 12%. See how you lose value based on what the MARKET does? That is why you should KNOW what the market is doing today and what the market cap rate is supported by actual closed sales instead of making guesses.

I have determined that this particular strip center should trade at a minimum 9 cap.  I want to buy at a 10 cap.  Deal is dead until further notice.

I also don't care what the market trades at in two years.  I keep real estate long term and don't typically sell.

Thanks for the input.

Join the Largest Real Estate Investing Community

Basic membership is free, forever.

By signing up, you indicate that you agree to the BiggerPockets Terms & Conditions.