Appropriate offers for underutilized commercial properties

3 Replies

I am new to commercial property, and only have two residential properties at the moment.  I have recently made two offers on two different commercial properties that I think are desirable, mostly because they're only partially rented out so there is lots of room to add value once I buy them.  Here is a summary of each property and how it ended up:

Property 1: Small six unit strip mall, total of 4300 square feet. Three of the units are rented out, totaling $825 per month income (for all three). The units that are rented out are priced under market value for their lease rate (they are friends of the landlord). The taxes total about $6,500 per year, and there are a few more expenses that aren't included in this cost (common water and septic, insurance, building maintenance, lot maintenance, etc.). Just based on the $6,500 in taxes and excluding the other unknown expenses (I know that's a bad idea), the NOI = $3,400 per year. Assuming a 10% CAP, the value of the property is approximately $34K. Their asking price is $300K. Obviously that's way too high, so I told them that I would continue to evaluate the property if they were willing to start at a price closer to $175K. They stated that if the property was fully rented out at the appropriate $ per square foot then it'd be worth about $300K. I agreed (which is why I wanted the property), but stated that I wasn't going to pay the fully leased rate if it's not fully leased, and that they can reach out to me at any time if they re-consider.

Property 2: Larger 7 unit building, also partially leased. Current NOI on that building is $9,915 per year. At a 10% CAP rate, that puts me at an offer price of $99,150. I also valued the property like the bank would (debt service coverage of 1.2, 5.5% interest over 20 years), and I came up with a value of almost exactly $100K again. Fully leased at appropriate lease rates, the NOI would be $32K, giving me a property value of around $320K. However, all of the units that are vacant need various amounts of work, and a few of the tenants are significantly under-paying on the lease value. Last, two of the leases (about half of the current income), is month to month.

The current owner listed the property at $230K, I offered $120K (20% over my assessed market value).  They declined the offer, and didn't bother to negotiate.  They told me that with partially or fully vacant property they usually calculate the value based on raw $ per square foot, not income.  That seems like what they would want to do, because the value comes out much higher that way!

I have heard that one of the biggest reasons to get into commercial property instead of residential is that the valuation is easy, there's a formula and you calculate the value and everybody agrees.  Obviously it's not that easy, but I'm 0/2 and haven't even gotten the chance to negotiate yet.  I know the thumb rules about how many properties you have to look at/inquire about/make offers on/etc. to get just one property, but I wanted to ask the question:  Am I doing something wrong?  Am I on the right track and just haven't found a motivated seller yet?  I believe I did right on the first property, but should I have offered more on the second one?  I would've been happy to pay $150K for it (or maybe slightly more with some seller financing options), but I wanted to leave some negotiating room to bring them down from $230K.

Any advice out there???

Would love to hear some feedback from more experienced investors out there on this topic - I've seen a few properties in my town similar to those you describe, and always wonder exactly how an investor "values" these more distressed, underutilized properties (in terms of offer VS turnkey asking prices).

Ha.ha. Property one is a joke. Looks like they want a sucker to pay for work they have not done or failed at doing.... : )

Sounds like an unmotivated lazy seller.

When looking at value add retail some do not look at any cap rate and some look at (going in) cap rate. I look at going in because I want to know worst case what the existing income is on a property if it takes longer to stabilize than anticipated.

Some want 5 cap on current and others 7 to 8 cap on current and blend the cap rate up once stabilized.

You have to define what YOUR TIME is worth and what return you want to work on a property. If a deal is too thin you pass until it becomes a workable deal or put energy into other properties where the seller has a higher motivation. 

@Jonathon Atherholt I bought several distressed commercial properties last year that needed work, had a lot of vacancy or were otherwise unloved. The approach I took was to give them a fair (or even generous) cap rate price for the income the property was currently generating but little to nothing for the vacant units. So far this has worked out pretty well for me. The properties break even or even generate a bit of cash flow with the tenants that were in place when I bought. But every tenant I add is pretty much pure profit.

Also, I would say that I somewhat agree with their assertion that they are selling based on the size of building not current income. For instance, if you can buy a 10,000 square foot empty strip center in a great area with lots of retail demand it's certainly worth more than the $0 income it's generating. Possibly approaching as much as it's replacement cost of $1 million or so.

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