5 unit commercial strip, is this a deal?

Commercial Real Estate Investing
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5 unit commercial strip, is this a deal?

Jarred Sleeth
Investor · Austin, TX · Member since 2014 · 144 posts · 86 votes

Hey BP,

I was out yesterday doing some shopping and the owners of the store I was in approached me about selling their other location. I'm a frequent customer and they know I buy real estate which is why they asked. They own the building their other location is at. It's a 5 unit strip center in a good location with two nationally franchised tenants, their store, a hair salon that has been there for a long time, and in the process of signing on the last unit which will be a nail salon. They have owned the building since 1997, and it was on a 99 year ground lease with roughly 65 years remaining. 

I'm posting here in hopes of learning a little bit about this ground lease and what the pros and cons of such an investment would be.  I invest for the long term for cash flow. They are asking 500k which is about 100k/unit, and at that price it didn't seem outrageous or anything. It's not currently on the market, but they are older and are tired of dealing with it. I don't know all of the numbers for income/expenses yet, but I'd like to know if this kind of deal is common and if it would make sense before I sit down with them to get more details.

Does this sound like a deal to you? What would you do? They are motivated and as far as I know I am the only one looking so far.

Thanks!

Jarred

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Daniel Chang
Professional · Riverside, CA · Member since 2009 · 254 posts · 273 votes
10y
Originally posted by @Jarred Sleeth:

@Daniel Chang

Thanks for the information. I'm wondering how useful this type of investment would be for me. The acquisition cost seems to be a sunk cost in the end, and the value would actually decrease over time rather than increase. Am I getting this right? For what reason might an investor like myself purchase a deal like this rather than a commercial deal that includes the building and land together?

Thanks!

How useful it would be to you is of course a question only you can answer.  Yes, as the years go on, overall the value would decrease because there's less future potential cash flow.  

Obviously, if everyone had their choice, they would own the property fee simple, meaning the building, land, with full rights of ownership.  Sometimes, it's a matter of capital.  The same building fee simple might be $1.5MM, whereas you can buy the leasehold estate for $500K (just an example).  Sometimes, it's the only option available if it's a property that suits your need as an owner user.

If you would earn an IRR of 20% with a leasehold estate, and a 15% for a similar property fee simple, which one would you rather have? Just remember, that it's not worth 0. If you were able to buy the rights for $50K per year for 65 years for a mere $1000, would you? Of course you would! Even though that $1000 is a "sunk cost" as you would put it. So if you would do $1000, then there is a valuation that makes sense to any investor.

Overall, my general recommendation is if you don't understand the investment, best to stay clear of it.  But it never hurts to get the financials and crunch some numbers.

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  • Nick L.
    Buy & Hold Investor · Milwaukee, WI · Member since 2012 · 378 posts · 179 votes
    10y

    @Jarred Sleeth Thanks for ploughing through my semi-inebriated rambling :) Now that I read it again, my vague word-math doesn't stand up to scrutiny. 

    > When you say after leverage, what do you mean? I understand leverage but I'm not sure I followed this in your scenario. 

    I meant that with leverage, the net cash flow is going to be lower than your NOI, but the return on investment is going to be higher. For example, say you buy a property for $500k cash and it throws off $50k/year NOI. In this case NOI = cash flow and your ROI will be 10%. By contrast, say you buy the same property for $500k with $100k down. Your annual P&I is about $30k so your net cash flow is $20k and your ROI is 20%.

    In my prior example, I was hand-waving at this math just to point out that you have to account for the difference between NOI and cash flow if you will be using leverage.

    > Also, could you expound on your comment about discount rate and reinvesting profits? What would this look like?

    OK so this refers to one of the core concepts of discounted cash flow. The discount rate, AKA opportunity cost, is the risk-adjusted rate of return you could be getting if you didn't take this investment. You have to decide for yourself what this is. The minimum is going to be something guaranteed safe like US Treasuries. The maximum might be some other project that promises to return 12% but is fairly risky so you moderate it down to 7%. There are many schools of thought on what this should be. 

    The higher the discount rate you use, the more attractive your project has to be in order to compete with it. This is because future cash flows are "discounted" back to net present value at the discount rate in order to figure out what that dollar tomorrow is worth today. 

    If you are interested in DCF, I personally like the Get REFM products but there are many other tutorials out there. Here are a couple of quick overviews.

    http://www.propertymetrics.com/blog/2013/03/12/dis...

    https://www.biggerpockets.com/renewsblog/2013/01/2...

    http://www.commercialcomplete.com/dcfmethod.htm

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  • Jarred Sleeth
    OP
    Investor · Austin, TX · Member since 2014 · 144 posts · 86 votes
    10y

    @Nick L.

    I got it. I thought that's what you were intending to say, so my understanding here is correct.

    As for DCF, I am going to read into these links you've provided. Thanks for that.

    Final thought. Is this kind of deal something that could be acquired with little or no money? I'm not familiar with commercial terms, but I know they are different. Does an owner financing scenario make any sense?

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  • Nick L.
    Buy & Hold Investor · Milwaukee, WI · Member since 2012 · 378 posts · 179 votes
    10y

    @Jarred Sleeth Maybe the current owners would consider giving you in a master lease + option. In this model you would run the property, pay them a fixed amount each month and keep any profits that you generate above that level. The option would give you the opportunity to buy them out completely in the future. 

    This would tie in well with @Shane H.'s line of thinking. Maybe you could secure the master lease and then separately approach the land owner to get a sale. If the math makes sense, you can close on both the land and the improvements at the same time. If not, you can just chug along with your master lease.

    There are a lot of ways you can play out this scenario. You have three powerful factors on your side: motivated sellers, a lot of goodwill and limited competition. You just have to figure out how to convert those into a good deal.

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  • Vincent Crane
    Realtor · Atlanta, GA · Member since 2015 · 693 posts · 357 votes
    10y

    Waiting 65 years for the lease to end isn't too bad I suppose

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  • Jarred Sleeth
    OP
    Investor · Austin, TX · Member since 2014 · 144 posts · 86 votes
    10y

    @Nick L.

    These are some great ideas. You're right in that I have a lot of things going for me in this scenario, and that I just need to figure out how to play my options. Once I figure out what all those options are ;)

    Thanks for the tips!

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