I'm evaluating a retail commercial deal. This is my first dive into the commercial side and to be quite honest I had no intention to be moving this direction after only 3 residential SFH under my belt but the more I look into it the better it sounds.
The property I'm looking at has 5 retail units totaling 6418 sqft. Monthly gross rents are $4770. Other monthly expenses given to me by the listing agent are:
Misc repairs: $2391
Tenants pay for their own water/sewer and electricity
I talked to a local appraiser and he told me that the rough CapRate in this area is 9. If I add to the supplied expenses another $100 a month for vacancy (I know this is low but it looks like I may be able to get a 10yr lease from the 3 largest units and the location is pretty good) and $200 a month for CapEx (perhaps also low but HVAC is relatively new and there is a metal roof which is relatively new). Using all the numbers above I get a CapRate value just under $500,000. The current asking price is in the high $500,000 range.
I've only spoken with two commercial lenders but one is offering terms of a 25 yr, 10 yr balloon, with 20% down at 5.34. This sounded pretty good and way better than the other lender I spoke with. If I can get it for around $500,000 (and that may be a big if) at the financing terms I mentioned I'd be looking at about $1080 a month cash flow after all expenses and a 12.5% ROI. The DCR would be about 1.45 which also seems pretty solid to me. I did ask the seller if they would consider owner financing to improve the financing even more but that did not fit into their needs.
This all sounds pretty good to me. Would love to hear any advice or comments particularly on the finance terms and if I am missing anything.
Be interesting to see what others say. Your deal looks remarkably similar to the one I'm looking at here in Mississippi. My big question on this deal I'm looking at is how much do you account for needed updates on the property. The 70% rule in single family says you take the ARVX70%-repairs=offer. I was wondering if that is realistic in commercial deals.
I think you may have mistyped the monthly expenses (adds up to over 8k), but I think your analysis below is spot-on. It ultimately depends on what your goals are as a buyer. If you are satisfied with a 12.5% cash-on-cash return then it's worth going after. If not, keep looking.
20% down on the financing is good. Wouldn't hurt to shop around more, but the terms you have right now seem pretty solid.
Can't speak for cap rates as I don't know that area, but 9 sounds right. Solid investment all around. It just depends on your goals.
Just looking at this off the cuff but those expense numbers look annual to me.
@Paul Smythe , thanks for your response Paul. Those are actually annual expenses.
@Brian Pinckard I figured. That makes much more sense. Seems like you're on the right track here and this could be a good investment for you.
You need to see what kind of leases are in place for NNN or gross leases, hybrid,etc.
Biggest expenses on retail centers tend to be roof, parking lot re-coat and seal, and heating and air units. You need to look into the leases to see who maintains what.
At 500,000 these almost have to be mom and pop tenants.
I work in the larges spaces for many millions of dollars and national type tenants. This sounds more of an older building mom and pop type stuff which might be a 9 cap who knows. Higher quality stiff with national tenants gets developed for 9 plus caps break even so they do not sell for that more in the 6's.
Key with these small mom and pop tenants is if they pay at,under, or above market rents? Are they single unit or multi unit operators? Is there a corporate guarantee on the lease and if so is it one store or all their stores? If just one store then they might can do a remote bankruptcy of the entity and without affecting themselves and screwing the landlord.
Ideally with small mom and pop tenants you want them on the hook for everything. You want personal guarantee and full corp all stores guarantee with quarterly reporting of business sales and financials as well as personal. Instead of them telling you they are doing well you can see in real time how the business is either growing or declining.
Check to make sure personal guarantee does not burn off early in the primary lease term or that they have early termination clauses if certain sales levels are not met.
Tons and tons of other items to look for. Good luck.
Thanks @Joel Owens . Definitely mom and pop type tenants and older building. The sellers occupy two of the units and are just looking to get out of the landlord business and perhaps take a 1/2 step toward retirement. They've expressed interest in a long term lease as well as the occupant of a third unit. You bring up a good point though in regards to how solid the businesses are and just because you have a ten year lease doesn't guarantee 10 years of payment. They seem solid and well respected businesses on the surface.
For you and others reading, I'm used to the residential side where you look at the property, write up the contract, and then parties sign or negotiate. On the commercial side is it true to assume you negotiate , verbally or written, before putting things down on paper? Seems like that would be the more logical way of doing things with all the variables in commercial deals.
Get full corporate and personal guarantees. That way down the line if they have problems with the business you have some negotiating leverage with the lease amendments or if they want to terminate a buyout provision to cover lost rent, TI, leasing commissions, and legal costs for the next tenant.
@Brian Pinckard Looks like an interesting deal! Regarding your last question in your last post, in commercial properties like that it is most common to negotiate with a Letter of Intent (LOI). It outlines the price you're offering as well as general terms and time-frames. It's non-binding so it's a good way to talk back and forth before incurring the expense of an attorney to draw up a contract. When you've agreed then you can give it to your attorney as the basics of the contract.
As someone else mentioned definitely try to find out what market rents are there. Find some nearby similar vacant space and call the numbers and find out what they're asking. That will also help you determine about how much vacancy is around you.
Also, you mentioned semi-retirement for the owners meaning they are older? Usually when I hear that I think to add some seller financing to the mix. Maybe they would take a small note for part of the down-payment and allow you to get in with lower cash.
Thanks @Jeff Kehl . That's real helpful. I asked the owner about seller financing but she wasn't interested. I think I'll readdress that avenue with them. She probably hears seller financing and thinks she won't see all her money for 30 years whereas it could be a real useful tool for them in how we set up the balloon payments.
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