Can u help me put this deal 2gether? $2mil partial owner finance

62 Replies

Appreciate the help and advice as this topic moves along.  A little long however figure the more info you know the better tailored your advice can be.

What I've got so far.  I met with a local gentleman who started investing in the early 90's.  After meeting with him and expressing his desire for privacy/discretion in sharing information he strikes me as the "millionaire next door" type - lives in a modest neighborhood, drives a modest car, does not want to be flashy, show off his wealth etc.

We've had the chance to meet for 2.5 hours so far.

He's in his 60's best I could tell - ready to retire.  Wants to divest part of his commercial portfolio - his stated goal is to give someone younger an opportunity and he's against selling the properties to one of the few wealthy families/dynasties that control a lot of things around here, does not want to sell through a broker or to someone with great wealth.

He stated he would not prefer to leave the property to his family and is mainly concerned with having an income stream for the next 30 years to carry him through retirement, not worried about living an extravagant lifestyle etc.  Through our conversation I understood he had owned various businesses and may still have some in existence.  Sounded like at one point he had nearly 100 employees working for him - now just has one.

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Property Breakdown - meat and potatoes
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6 Properties total - I'd call it a "C" grade area, an older area of town built up in the 50's and 60's.  All properties are supposed to be close together and  very close to one of the hospitals (we have 3 large ones in town) and all have very easy highway access, and fairly centrally located on main arterials.  It's not a bad area, just not "new & shiny."   Not the poorest of areas, definitely not the wealthiest of areas, the large local grocery chain still maintains grocery stores there, starbucks/wal greens can be found etc.

2 shopping centers, one free standing office building, 3 other mixed use properties that have restaurants, retail and office space.  He is reporting tax value is near 3 million.  He's willing to exit at 2 million, would like 20% down and he would finance the rest so 1.6 mil and he wants a payment of $5555.55 per mo for 30 years which equates to about a 1.65% interest rate.

He may also be willing to partner with a potential buyer -- ie they turn around the properties, and when they are in a better cash position or better able to secure financing for a 20% down payment they buy him out, he may still owner carry the rest at that point as well.

So far I've only only received limited info and have not been able to see the properties as we are just beginning to talk.  He mentioned a non disclosure agreement so would assume we'll need to put one together before being given the line by line details.  I was given the general vicinity and am 99% certain I met him at one of the restaurants included in the package.  I do not have the # of tenants, but he stated to me there is some deferred maintenance, and high vacancy, however he's still cash flowing on all the properties as I was able to see his IRS Schedule E - redacted of course.  States he does not have the desire to focus all of his attention on the properties and wants to move on.  Says someone with new energy should do fine.  He has stated he has been easy going on tenants and some he has not raised the rents in 20 years among other things.

#'s on the IRS Sched E  (rounding for easier math)  (He does not have mortgages on every property - just the 2 shopping centers)
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Prop 1 - Shopping Center 55,000 SF

  • $110500                  Rents (states if full should be appx $264000)
  • $36700                    Earnings after op expenses  before Dep & Mortgage Interest 

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Prop 2 - Office Building - 12,000 SF   (I believe he occupies about 1/3 of it but will move out -- he does not pay rent on this portion of course, uses it as a writeoff)

  • $22200                    Rents (says if you lease space he uses income would be higher)
  • $8075                      Earnings after op expenses before dep &  mortgage interest

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Prop 3 - Restaurant & Offices   (wasn't given sq footage)

  • $11400                    Rents  (says it should be appx $18k)
  • $2000                      Earnings after op expenses before dep & mortgage interest

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Prop 4 - Shopping Center I believe...unk sq footage - didnt get a lot of details on this one

  • $72000                    Rents - unk if it should be higher
  • $24400                    Earnings after op expenses before dep & mortgage interest

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Prop 5 - Restaurant - unk sq footage - got the impression this bldg was near the end of it's life - said best thing is at some point, scrape and rebuild - this may be a national restaurant and for the most part a NNN lease - made the comment every couple of years they tell him what they will renew the lease for. Not much he does with this one

  • $12800                    Rents 
  • $10400                   Earnings after op expenses & before dep & mortgage interest

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Prop 6 - Storefront - unk sq footage or if rents are low

  • $22200                    Rents
  • $7600                     Earnings after op expenses & before dept & mortgage interest

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(Based on what he provided me - he earned appx $88k on the 6 properties before taking into account the 2 mortgages he has left and depreciation so unsure of what his exact cash flow was)

I do not know the vacancy percentage at each property - he left the impression it was high, stated one of the large wealthy familes in town who own a lot of retail space have lured some of his former tenants to their properties while he wasn't paying as close attention as he should as they gave signs they were being courted elsewhere, however he missed that.

2 Nationals and lots of mom/pops - no tattoo shops, no vape shops, no check cashing places, no liquor stores.  Only one church - however has been a good long term tenant - reverends family is extremely wealthy and always makes sure the bills are paid.

Is there something here?  I believe there is.  Throwing this out there - anyone with experience in these deals interested in entertaining a partnership?  I'd consider with an experienced individual or will figure out how to do this on my own if this is worth doing.

I've got an email in to him asking for vacancy percentage and # of units at each property.  We plan to meet again soon.

Updated almost 6 years ago

I realize based on the figures he provided me he's wanting to sell for an appx cap rate of 4.5% I'm sure the final price is negotiable of course, however once can't ignore the power of the owner carry here and the upside that appears to be here. Set me straight guys/gals

So far I'm thinking my 3 options are (provided the properties check out and are what he says they are, have upside, not too costly to repair amongst other things.

#1 - see if a bank would lend me $400k for the down payment - Owner would owner carry $1.6 mil - however payments would not start until possibly end of year one or two....maybe this could be modified with a 10% down payment - so borrow $200k 1st year, borrow $200k 2nd year, then owner carry payments start year 3 -- either way figure it will only work if he's willing to start taking payments a year or 2 after I would take control to give me time to put money back in the properties and get them turned around.

#2 - partner with owner in some fashion - we work together for say 5 years -- at the end of 5 years I have the option to buy at an agreed price?

#3 - partner with an outsider who can provide some of the capital (I can provide some of the down payment)  -- Either buy present owner out completely or utilize his owner financing.

@Shane H.

I'd recommend you proceed with caution. This doesn't seem like much of a deal and that's based on the figures he is giving you, not what you can verify. With a 1.6M Loan, you're looking at mortgage payments somewhere in the $9,000 range, depending on what terms you can negotiate on the seller side. That doesn't include CapEx, maintenance, management, taxes, insurance, etc.

Given that you're looking to borrow the capital for the down payment, I'm not sure how you will manage the instant negative cash flow you inherit.  Additionally, if anything breaks or you have unplanned additional vacancies, I can see this going downhill quick.

To me, this sounds like a deal where the current landlord is inexperienced and/or lazy and is hemorrhaging money and he is looking for someone who isn't savvy to buy his problem for him. This could explain his true reason for not wanting to sell to his wealthy friends.  I realize that I'm far more cynical than your average person, but it helps me get by in business :)

With that being said, there could be upside if what he said was true and you have the knowledge, experience, financial backing, and skills to turn around commercial properties. You will also need to examine your local market and determine what a fair cap rate is for properties of this nature. Given that he currently has ~250k in gross rents and is a Class C Neighborhood, If this were local to me, I would be interested if he halved his asking price. 

-Christopher

In commercial if these properties are built in the 50's and 60's they have already surpassed the time to be torn down.

Usually shopping centers regenerate every 20 to 30 years. Land becomes more scarce and the local county or city usually votes to improve density per acre which encourages redevelopment along with reductions of impact fees charged.

Basically you need to look at the dirt these properties are sitting on. If that is valuable i would me more excited about that. The older buildings likely have asbestos and demo and scrape costs will be higher.  It's better to sell to a developer and let them take the risk of lost rents and ready to go vertical with new improvements.

That is nuts to put 400,000 down on such a property.  His statements do not match because you need at least 400k down plus closing costs plus have to set aside money for the turn around with tenant improvements, legal contract fees, and leasing commissions at a minimum.

So you are talking 1 million easy all in on this. That's not your everyday Joe! lol

Sounds like a no money down master lease option with no recourse against you might be better. You put time in and if it doesn't work out you walk away but gain experience.

You are either tearing this stuff down or renting at a very low per sq ft to attract tenants. Mom and pop tenants usually do not have many funds for their own TI's even at a reduced rental rate because they are mortgaging their house to get and keep the business going. That versus national tenants that for a great lease rate will pony up the money to build out themselves. Especially on an older building you do not want to outlay heavy TI's if the building is just going to be torn down in a few years etc. You want it filled with zero TI's and some free rent to get them going etc.     

@Shane H.

I don't see the value of the owner carry if you still need to put down 20%. You could just use regular financing. Or if is forced to carry the note because the buildings won't appraise out in regular financing due to the low cap rates, poor quality tenants and deferred maintenance, that strongly suggests it's a bad deal.

I could see the deal working per your option #2, where you have some sort of partnership with the seller that includes an option to purchase at a pre-determined price after say 5 years. @Joel Owens ' suggestion of a master lease + option fits this model. You would still have to put time and money into maintenance, TIs and lease ups but at least you're compensated by not tying up a downpayment and getting an instant equity boost when you exercise the option. Of course you would have to be pretty sure you can get the properties financed on the terms you need at the end of the option period, otherwise you will have put in a lot of work and money for no reward.

I would also think very carefully about the competitive situation of the buildings. If tenants are getting lured away to better buildings at lower occupancy costs than you can offer, you are likely to be in a declining competitive position. Of course it's possible that the seller has just been lazy over the years and you can turn things around, but as @Christopher Brainard said it's also possible that he's trying to foist a bad hand onto a sucker. You have to be very sure which one it is!

@Christopher Brainard @Nick L. @Joel Owens

Thanks for the advice so far.  I was thinking the partnership would be the best route or if I say borrowed what he wanted for a down payment, if he delayed receiving payments on his owner carry portion for a year or two that would free up quite a bit of cash flow initially to get things turned around.  I naturally have quite a bit more homework to complete, however I consider myself a pretty good judge of character and do believe his intentions so far.  As far as the sucker he didn't strike me as the type of person to try and get one over on someone else.  My present day job has trained me quite well to read people and their level of truthfulness.

If some of the property is where I believe it is, the land should be fairly valuable and if a couple of the restaurants are what I believe they are, they have been in place for years and one of them is somewhat of an institution in town due to it's age...think a diners, drive-ins and dives type of place you'd see on the Food Network.  He manages the property himself and I think per his admission he just has not paid attention to them as he should have been.  I was the one that brought up if he had problems losing tenants and mentioned the other competitors...which are in all admission large corporate run outfits....They might offer a sweetener to steal a tenant away however they'll also be the first to put the screws to someone so to speak once you are in their property.  

Will be meeting again soon and see where it goes.   

Looking at his schedule E he did mention one of the properties he had a reserve account built up for repairs and had not used the money yet, but it is set aside to be spent on improvements already.  It appeared to be a decent amount of money.  One roof needs replacement  and gets patched every year, one is 5 years old, others in OK shape.

The challenge I will have is putting a value on properties that are underperforming -- if say a property is 70% vacant - do you value it as the #'s are, build some upside in, how do you account for deferred maintenance amongst other things?

@Shane H. It looks like you've thought things through. It's an unusual deal but might work out well. 

As to valuation, I would run it two ways. One way is an as-is performance - you have already determined that to be a 4.5 cap. The other one is performance at the time of exercising the option (ignoring inflation to make them comparable). 

For example, say you figure that the valuation in 5 years is $3m (in 2015 dollars), and you have had to plug in $400k in improvements/TIs from your own pocket and pay off the seller at $2m. This gives you a $600k profit or 150% ROI on your capital invested. You can also compare the cap rate directly to the initial 4.5%.

Another way of looking at it would be on a post-option cash flow basis. You would exercise the option and be sitting on a $3m property with a $2.4m/80% loan and $600k/20% equity. (In this scenario the refi allowed you to pay yourself back the $400k capital invested.) You could calculate the cash flow at that time and figure it as a % of the $600k equity to get your ROE. 

If the future figures are attractive and feasible, then make the deal. If not then figure out what current deal terms would make those future profits and cash flow attractive.

Sometimes if it is old buildings and tenants and valuable land you want them gone. If I can get a pharmacy to go a corner where a dumpy old restaurant was before I can land a big payday.

Some investors just look only at what something is and it throws off. You can unlock a lot of value with development experience that the seller doesn't have. 

Still keeping in touch with the local investor from time to time.  

Spoke to him a bit today and I think what he's now trying to get figured out is his tax situation.  He said if he sold the property outright with the depreciation he's taken, he'd be hit at around $200k in income tax and would like to avoid that if he can.  Dont think he'd like to do a 1031 and was going to think through some other options.

He had mentioned forming a general partnership, myself or whomever he'd like to sell to would become a general partner and either work/manage for equity that could be gifted over etc, spread the taxes for him out over time.   He stated he has only taken about half the depreciation so has not owned the buildings long enough to take the full depreciation amounts yet.

Any references one might point me to, to study up on the tax subject a bit more?  Or maybe a suggestion that could be passed along to him in regards to a strategy to help spread the tax burden or avoid some of it if possible?

Of course I understand any advice or answers given are simply advice and not considered legally binding in any nature and you're held harmless etc.

Much appreciated.  Will keep following up with him to see where this goes.  Have nothing to lose at this point.  We're supposed to have lunch again in the next month.

@Christopher Brainard @Nick L.  @Joel Owens  

So, he's concerned about $200k taxable income on a $2M sale? I wish I had those problems ;) If he does the seller financing, I believe he would be taxed in smaller increments over the life of the loan. I don't think I quite understand what he's getting at.

More to the point, the deal still doesn't make sense for you, you're essentially getting this cluster of properties at a 4.5% cap rate. While there may be improvements you can make to improve the NOI, you've got a long way to go for a decent deal and you shouldn't be paying a premium for cleaning up his mess.

Maybe its just me, but I'm just not seeing the value here.

-Christopher

Originally posted by @Christopher Brainard :

So, he's concerned about $200k taxable income on a $2M sale? I wish I had those problems ;) If he does the seller financing, I believe he would be taxed in smaller increments over the life of the loan. I don't think I quite understand what he's getting at.

More to the point, the deal still doesn't make sense for you, you're essentially getting this cluster of properties at a 4.5% cap rate. While there may be improvements you can make to improve the NOI, you've got a long way to go for a decent deal and you shouldn't be paying a premium for cleaning up his mess.

Maybe its just me, but I'm just not seeing the value here.

-Christopher

I agree.  I figure I have nothing to lose by learning more.  I need more info from him to formulate a better decision myself.  Guess I'll just use this post as a diary of the potential deal.

My instincts tell me he was sincere in what I had discussed about his intentions above but we shall see.

Owner finance is worthless when the terms and price are no good.

You say you having nothing to lose but that isn't true. Getting into a partnership with a bad deal or owning yourself you are giving up time. Time you could be looking for a property that does work.

Believe me experience teaches you certain things. These days I walk away from deals that do not make sense or put me in a bad position. I stay in touch with them until they meet my terms or someone else buys it.

@Shane H.

I guess my concern is more over the future performance of the properties than over the way you structure the deal. 

If the area is attractive and you anticipate that you will be able to fill the vacancies with good tenants at good rates and with minimal TI expenditure, it's worth figuring out a way to make the deal work.

If they are in a declining competitive position with aging buildings and no underlying land value, you are being offered what Warren Buffett calls a cigar butt. If the price is cheap enough that one last puff might be worthwhile, but I wouldn't pay Havana cigar prices for a discarded Swisher Sweets.

So far it sounds like the only evidence of upside is vague comments from the seller. So my overall impression is that you are venturing into cigar butt territory. 

Was able to meet for lunch with the potential seller today and see part of the properties.  Im a little surprised.  Was a little better than I thought.

Saw 2 of the parcels.  One had a mix of office and restaurant space - somewhat run down but location wise not too bad.  It touches and shares property lines with one of our hospitals (we only have 3) and has frontage on a main arterial road.  It's in an older part of town, lots of money has been pumped into properties across the street and up and down the arterial with plenty of national restaurant tenants nearby.  Household wise plenty of people around, however not in the highest income area.  This one needs plenty of work or could be scraped for something else and depending on what you'd do with it would be a candidate for a public/private partnership with the city or state.

2nd property is an office property but is an A to A+ property in an A++ location.  I didnt get to go inside but am very familiar with the area.  If he put it on the open market he'd have lots of people likely wanting to buy it.  Steady tenants inside.

We ran out of time and should see the remaining properties next visit.  He seems concerned as i had alluded to about taxes and his legacy - as I think when he passes he'd like to donate everything to charity.  Supposed to possibly have lunch again in a month or so.  Still could be something here and the mention of forming a general partnership, a possible master lease, or him forming some sort of charitable trust have been touched on lightly.

@Timothy Aughinbaugh @Account Closed

@Shane H.

I was surprised to get notified about this deal - I thought you dumped it long ago. I think the general consensus was that the price he was looking for was unattractive, even with the owner carry, and the down payment was too high. If he is really just concerned about his legacy and/or charity, I'm sure he could be flexible on the down payment and total price. In the end, it is really going to come down to your long term plan and ROI. As an investor, you can't be focused on the seller' legacy. Stay focused on your business.

-Christopher

@Christopher Brainard

Oh believe me -- I've mentioned to him multiple times it either works for both of us or it doesnt work at all.  He knows everything is negotiable and I've kept in touch with him as I have nothing to lose and he seems like a decent guy anyways but with quite a few quirks and who doesnt have those?  I've had other things I've been working on in the mean time but figured it was worth keeping on the back burner until something else superseded it.

@Shane H. Glad you're keeping in touch but like @Christopher Brainard I have concerns over the performance of the deal. Any way you cut it, a 4.5% cap rate is far from great, especially on retail and offices. 

Any chance you could cherry pick the most desirable properties and leave the rest?

@Nick L.

It could be possible.  I'm sure he would want everything as a package deal.  I'll be able to formulate a better plan once I see the rest and get to know him a bit better.  He's the type you need to develop a relationship with before you can get anywhere.  Not much different than some farmers/ranchers I encounter when I ask for hunting permission in the fall.  They just need to know you're not a bad guy and they'll open the book for you at some point so to speak once they get to know you.  Once you have the relationship the deal or what you are offered often gets much better. Hope that makes sense.

I hear you. You're right to continue engaging with him. Some sellers just want to feel comfortable with the buyer. Maybe a good personal relationship will lead to a better outcome for everyone in the end.