Deal or No Deal? Buying out business partners

11 Replies

Hi all,

Wanted to get your advice on whether I should buy out my business partners on a commercial building we own or just hold my current position and call it a day.

We own a building in downtown Orlando FL (3300 sq ft), good location, cosmetically renovated inside, new roof, etc. We bought the building in 2012 for $550K and made about $250K in renovations. We currently owe $340K on the loan and have roughly $40K in the bank. I "think" the building is probably worth $800-850K currently. 

The proposed deal would be that I pay each of them $150K and they are removed from the partnership and I become the sole owner. Additionally, I would pay off the remainder of the loan. So I would be out of pocket $600-650K ($300K to them and $340K to the loan + whatever money remains in the checking account).

We have an offer to lease the building out at $30/sq ft NNN, but they want some additional offices added. Also, I am not sure this deal is completely "solid" as of yet and the building has been on the market for lease for about 2-3 months. Here are the numbers on the office currently:

Mortgage: $2,900/monthly (I would be paying this off)
Property Taxes: $900/monthly (paid by tenant on triple net lease)
Insurance: $585/monthly (paid by tenant on triple net lease)
Sales Tax: 6% (paid by tenant on triple net lease)
Reserves: $750 (I recommend keeping at least this amount aside per month)
Lease Commission: 4-6% but likely 6% if working with outside broker. 6% would be another $510/monthly to account for although 50% of this payment is due upfront upon closing on the lease.
Misc.: Other misc fees such as Tax prep, accounting, licenses, pest control, etc. etc. $400/monthly

According to my calculations, I would have outgoing costs of roughly $1700 per month and my rental income would be $8200 per month. Also, I don't mind managing the property myself.

My question is, would you make this deal if you have cash on hand and would ideally like to bring in some passive rental income? Are there any other expenses or items I am overlooking?

I appreciate all thoughts,

Skip

Why would you payoff the loan?? Is it a high interest rate??

The value is tied to the income of the property. If you lease up the other space you could cash out refi likely at 75% ltv with a larger value.

Why can't the lender just release the other partners off the loan and you preserve your cash??

   

Originally posted by @Joel Owens :

Why would you payoff the loan?? Is it a high interest rate??

The value is tied to the income of the property. If you lease up the other space you could cash out refi likely at 75% ltv with a larger value.

Why can't the lender just release the other partners off the loan and you preserve your cash??

   

Hey Joel,

Good point on not paying off the loan. I can either pay it off or release the partners from the loan. What I am more concerned with is trying to figure out if I am missing any costs I am overlooking and if the deal overall sounds good from a cash flow generation perspective.

I did speak to our broker who has the property on the market and he said that commercial properties have a tendency to take longer to lease out.

Thanks @Andrew Davis !

What was your original basis in the partnership??

Original purchase and renovations 800k at 3,300 sq ft  = 242.42 a foot

Out of that 800k how much cash do you have in yourself already??

Let's say hypothetically you have put in 150,000 so far. You will be 800k all in ( 650k buyout ) for a monthly rent of 8,250 and your estimated costs of 1,700 a month = 6,550 a month.

78,600 a year net pre-tax.

You are getting about a 10% annual return on your money but is based off of one tenant.

Office is generally not NNN structure unless medical. Usually some kind of gross lease is used.

What the property is worth and how it can be financed depends on the strength of the tenants credit and who is guaranteeing the lease and terms for primary ( years ). 3,300 space is almost a junior box size. Has your broker performed a "void analysis" to see who the optimal tenant to go in would be?? If you can land a national tenant versus a mom and pop the cap rate you can sell at is more compressed generally which increases your exit value especially on a newly minted NNN lease. Do not let the national tenant put a subsidiary is guaranteeing it or just that location as it makes your value weaker. The lender giving a refi loan eventually or when you sell the buyers lender will want strong credit with a parent corp guarantee otherwise they require more money down and a higher DSCR for risk. That lowers the buyers cash on cash annually generated off of a larger required down payment so they want to pay you less on the sales price.

30 NNN is pretty stout. I would make sure that wasn't overinflated for the market. If you sign this lease and they agree to a higher amount for TI above market you would not get the full value unless they stayed throughout the full primary lease term and the rents caught up to your lease. If that doesn't happen a lender on a refi or selling will discount the lease value to market. So with rent increases say you sell in year 5 with a value of 33 sq ft but market average with an appraisal is 27. The lender will only count 27 a ft. They do not care you went higher to recoup TI costs upfront. They will look at it as if the tenant vacates and releasing occurs you will have 27 if lucky for top market and additional TI's and LC's.

Right now your building is sitting in "cold, dark, shell condition" and has limited value with no tenant and lease in place except for your dirt. A lender would want to know the dirt is worth at least the loan balance.

10% is not bad for a credit national tenant. Before looking at buying out partners and dumping large amounts of cash you really need to nail down a tenant first. Right now you have nothing. You have a broker telling you a tenant is on the hook. They have to submit and LOI. From there attorneys have to be engaged to negotiate the full lease. Build out has to occur with changes and the tenant usually requests free rent and TI. Occupancy is taken when proper license and permits are approved.

If the tenant ends up paying 25 sq ft instead of 30 your projected numbers are affected.

My clients hit about 15% to 19% coc but we are going after retail strip centers with 25% down using CMBS non-recourse debt. We like the idea of having 10 tenants for breakeven occupancy versus one larger tenant that is harder to rent and when it goes vacant takes even longer to re-rent.

I did loose numbers here as an example so is not 100% accurate.

No legal advice given.     

Joel, excellent information! I really appreciate the in depth analysis. It's clear you have been doing this for some time.

My basis in the partnership is probably right around $125K or $220 per ft. I would pay them $150K each + we have a loan for $340K. On top of that I would be taking over the company and subsequent checking account with $40K in it. So all in I would be at $725K, and my broker thinks the building is worth between $800-850K (roughly). My estimated costs if the building is leased are $1,700/monthly. If the building is not leased it would jump up closer to $2,500/monthly.

I spoke to my broker this morning and it appears we don't have a solid lease lined up yet. The interested party is not sure it would fit their expansion plan so they are on the fence right now. My broker did say I should be able to get a NNN lease because it's a stand alone building with its own parking and signage. It can park roughly 8 cars which is a pretty good bonus in downtown Orlando. My broker did admit the pricing we have is on the high side, so that is a definite concern for me. As a matter of fact, my biggest concern is the building sitting empty. The building is very modern and newly renovated, looks kind of like a Google office, very techie and open, just to give you an idea. It will take the right prospect but the right prospect would fall in love with the place.

My broker has not performed a void analysis but I will speak to him about that. I also tend to agree with your recommendation of not buying the property until a tenant is secured. Basically setup the offer and deal structure contingent upon getting a minimum 5 year lease in place from a credit worthy prospect.

Any other thoughts are welcome.

Thanks again,
Skip


Originally posted by @Joel Owens :

What was your original basis in the partnership??

Original purchase and renovations 800k at 3,300 sq ft  = 242.42 a foot

Out of that 800k how much cash do you have in yourself already??

Let's say hypothetically you have put in 150,000 so far. You will be 800k all in ( 650k buyout ) for a monthly rent of 8,250 and your estimated costs of 1,700 a month = 6,550 a month.

78,600 a year net pre-tax.

You are getting about a 10% annual return on your money but is based off of one tenant.

Office is generally not NNN structure unless medical. Usually some kind of gross lease is used.

What the property is worth and how it can be financed depends on the strength of the tenants credit and who is guaranteeing the lease and terms for primary ( years ). 3,300 space is almost a junior box size. Has your broker performed a "void analysis" to see who the optimal tenant to go in would be?? If you can land a national tenant versus a mom and pop the cap rate you can sell at is more compressed generally which increases your exit value especially on a newly minted NNN lease. Do not let the national tenant put a subsidiary is guaranteeing it or just that location as it makes your value weaker. The lender giving a refi loan eventually or when you sell the buyers lender will want strong credit with a parent corp guarantee otherwise they require more money down and a higher DSCR for risk. That lowers the buyers cash on cash annually generated off of a larger required down payment so they want to pay you less on the sales price.

30 NNN is pretty stout. I would make sure that wasn't overinflated for the market. If you sign this lease and they agree to a higher amount for TI above market you would not get the full value unless they stayed throughout the full primary lease term and the rents caught up to your lease. If that doesn't happen a lender on a refi or selling will discount the lease value to market. So with rent increases say you sell in year 5 with a value of 33 sq ft but market average with an appraisal is 27. The lender will only count 27 a ft. They do not care you went higher to recoup TI costs upfront. They will look at it as if the tenant vacates and releasing occurs you will have 27 if lucky for top market and additional TI's and LC's.

Right now your building is sitting in "cold, dark, shell condition" and has limited value with no tenant and lease in place except for your dirt. A lender would want to know the dirt is worth at least the loan balance.

10% is not bad for a credit national tenant. Before looking at buying out partners and dumping large amounts of cash you really need to nail down a tenant first. Right now you have nothing. You have a broker telling you a tenant is on the hook. They have to submit and LOI. From there attorneys have to be engaged to negotiate the full lease. Build out has to occur with changes and the tenant usually requests free rent and TI. Occupancy is taken when proper license and permits are approved.

If the tenant ends up paying 25 sq ft instead of 30 your projected numbers are affected.

My clients hit about 15% to 19% coc but we are going after retail strip centers with 25% down using CMBS non-recourse debt. We like the idea of having 10 tenants for breakeven occupancy versus one larger tenant that is harder to rent and when it goes vacant takes even longer to re-rent.

I did loose numbers here as an example so is not 100% accurate.

No legal advice given.     

Regardless of whether you buy your partners out or not you were all dependent on and your strategy was to cash flow. 

There may not be a better time for your partners to accept your offer of a buy out because you are not making money now. When and if you do get an excellent tenant in and are making money then there will be a lessor motive to want or accept a buy out and even if accepted may not be at the same simple price that you are thinking. 

On the other hand your money is not growing now and if you put more of your own money into the building you will only have more of your money sitting idle also without earning. 

It does make sense not to do anything until you do have a tenant and a lease agreement that will pay enough money to offset your costs.

You accepted to take a risk and are now considering adding to that risk.

I do not know your situation but are you possibly putting all your eggs in one basket here. Same thinking would be applied as to whether you are considering leasing to one tenant or multiple tenants.

Who would be your ideal tenant and how will you attract them?

Does it make more sense for you to consider buying another property with your money instead of buying out your partners and paying off the loan? I mean one that would cash flow positive. If the building is going to become a positive investment, one that cash flows it will do that whether you have partners or not and same if it is not going to cash flow or appreciate much, same result.

You seem to have the cash now so a refi would not really be a motive for you unless your building really goes up in value.

I might consider paying off the loan beings that you are decided to hang on to the project and you really believe in it. At least this way you cut down on the negative you are experiencing now. 

Think what might be the advantages and the disadvantages of having partners. 

When it comes to NNN leases you may find but at least examine if your thinking is not more optimistic than you will actually be able to put into practice.

Everyone thinks of leasing to national brands just keep in mind that they are probably professional tenant/leasee/renters and will be looking for the most advantageous lease they can get Yet having a national brand may affect the valuation of your building or a consideration for lenders in the case of sale or refinancing at whatever time that may become an option you desire to take. 

By expanding your personal investment in this building you may also be extending your break even point. Ask yourself how long you want to wait before you get your money back. 

If you own the building and lets say in your building the per square foot price did go up to $33/sq. ft per your lease agreement or for whatever reason and the market rate went down to $27/Sq.ft all it would mean is that your building valuation might be a little less but then if you owned it then its still your money. How long would that take to happen and how much of your original investment whether added to by operating and holding cost or not take to recoup?

I might have more to say but what is the point if you are in this situation and you want to consider things applicable to your reality.

These are just some things I would think over and consider carefully before making a decision about buying out my partners and paying off the existing loan. 

Sorry I have no magic to offer you. The decision is yours to make.

Skip on single tenant NNN 5 year primary term leases are NOT COMMON.

3 to 5 years is common for retail strip centers with multiple tenants but lenders underwrite the risk differently on those due to smaller spaces going vacant, staggered leases, multiple tenant credit guarantees ( risk spread out on multiple businesses instead of one ), etc.

For a single free standing building 10 year primary is minimum and they go up to 25 years with pharmacies.

The reason is anything under 10 years left on primary it is hard to get lender finance. If lenders do finance they want a short term amort. schedule (15 etc.) with about 40% or more down. This way the balance of the loan is accelerated down at a fast rate but the buyer has almost no cash flow and just principal pay down. The lenders DO NOT count the option periods as it is not guaranteed to renew from the tenants. They might leave or renegotiate the lease in place.

As the lease goes under the 10 year mark the sell cap rate has to start rising because the value is tied to the lease income stream.

A tenant 15 or 20 year lease is much more valuable. You hold for five years and want to sell you still have 10 to 15 on the primary lease. Lenders will generally give a buyer 25% down in that instance because with a 25 year amort. schedule will at least be close to dark value when the primary term ends. The lender can then get about the balance on the loan and be made whole if they have to take the property back when the owner has no luck re-leasing etc.    

Gilbert, good points. I am taking all of this in and appreciate your input.


Originally posted by @Gilbert Dominguez :

Regardless of whether you buy your partners out or not you were all dependent on and your strategy was to cash flow. 

There may not be a better time for your partners to accept your offer of a buy out because you are not making money now. When and if you do get an excellent tenant in and are making money then there will be a lessor motive to want or accept a buy out and even if accepted may not be at the same simple price that you are thinking. 

On the other hand your money is not growing now and if you put more of your own money into the building you will only have more of your money sitting idle also without earning. 

It does make sense not to do anything until you do have a tenant and a lease agreement that will pay enough money to offset your costs.

You accepted to take a risk and are now considering adding to that risk.

I do not know your situation but are you possibly putting all your eggs in one basket here. Same thinking would be applied as to whether you are considering leasing to one tenant or multiple tenants.

Who would be your ideal tenant and how will you attract them?

Does it make more sense for you to consider buying another property with your money instead of buying out your partners and paying off the loan? I mean one that would cash flow positive. If the building is going to become a positive investment, one that cash flows it will do that whether you have partners or not and same if it is not going to cash flow or appreciate much, same result.

You seem to have the cash now so a refi would not really be a motive for you unless your building really goes up in value.

I might consider paying off the loan beings that you are decided to hang on to the project and you really believe in it. At least this way you cut down on the negative you are experiencing now. 

Think what might be the advantages and the disadvantages of having partners. 

When it comes to NNN leases you may find but at least examine if your thinking is not more optimistic than you will actually be able to put into practice.

Everyone thinks of leasing to national brands just keep in mind that they are probably professional tenant/leasee/renters and will be looking for the most advantageous lease they can get Yet having a national brand may affect the valuation of your building or a consideration for lenders in the case of sale or refinancing at whatever time that may become an option you desire to take. 

By expanding your personal investment in this building you may also be extending your break even point. Ask yourself how long you want to wait before you get your money back. 

If you own the building and lets say in your building the per square foot price did go up to $33/sq. ft per your lease agreement or for whatever reason and the market rate went down to $27/Sq.ft all it would mean is that your building valuation might be a little less but then if you owned it then its still your money. How long would that take to happen and how much of your original investment whether added to by operating and holding cost or not take to recoup?

I might have more to say but what is the point if you are in this situation and you want to consider things applicable to your reality.

These are just some things I would think over and consider carefully before making a decision about buying out my partners and paying off the existing loan. 

Sorry I have no magic to offer you. The decision is yours to make.

So are you saying a 5 year lease is not ideal on the building and would aim more for 10 years plus?

Originally posted by @Joel Owens :

Skip on single tenant NNN 5 year primary term leases are NOT COMMON.

3 to 5 years is common for retail strip centers with multiple tenants but lenders underwrite the risk differently on those due to smaller spaces going vacant, staggered leases, multiple tenant credit guarantees ( risk spread out on multiple businesses instead of one ), etc.

For a single free standing building 10 year primary is minimum and they go up to 25 years with pharmacies.

The reason is anything under 10 years left on primary it is hard to get lender finance. If lenders do finance they want a short term amort. schedule (15 etc.) with about 40% or more down. This way the balance of the loan is accelerated down at a fast rate but the buyer has almost no cash flow and just principal pay down. The lenders DO NOT count the option periods as it is not guaranteed to renew from the tenants. They might leave or renegotiate the lease in place.

As the lease goes under the 10 year mark the sell cap rate has to start rising because the value is tied to the lease income stream.

A tenant 15 or 20 year lease is much more valuable. You hold for five years and want to sell you still have 10 to 15 on the primary lease. Lenders will generally give a buyer 25% down in that instance because with a 25 year amort. schedule will at least be close to dark value when the primary term ends. The lender can then get about the balance on the loan and be made whole if they have to take the property back when the owner has no luck re-leasing etc.    

5 year lease is not the standard for single NNN.

Newly minted leases are at least 10 years for primary term.

NNN single property buyers like stability. They want that stream guaranteed for as long as possible. The more the security the lower the cap rate they are generally willing to pay for it.

A large tenant signing for 5 years is great for the tenant but does not give you a saleable asset down the road.   

Originally posted by @Joel Owens :

5 year lease is not the standard for single NNN.

Newly minted leases are at least 10 years for primary term.

NNN single property buyers like stability. They want that stream guaranteed for as long as possible. The more the security the lower the cap rate they are generally willing to pay for it.

A large tenant signing for 5 years is great for the tenant but does not give you a saleable asset down the road.   

Makes sense, Joel. Thanks again

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