How to create serious value in commercial :)

[David Switzer]

I have a unique niche in CRE where I only buy vacant units, or units with month-to-month tenants. The reason I do this is because when you buy a property with a tenant, you are paying for the cash-flow and there is often little value-add that can be done. In the last 3 years I have done this same deal style 4 times, and below is the most recent.

While looking at purchasing a mixed-use 3-story building with commercial on the ground level, I was actively reaching out to local businesses in the area asking if they would be interested in adding a new location or moving to a nicer location.  One local tenant, a successful dog daycare, said they were very interested because the backyard belonged to the commercial unit, which is very rare in this area.  This looked to be a great deal, but unfortunately the inspection revealed major structural issues with the building and we decided it was not worth the headache.

However, now we had a tenant who actively wanted to lease space, which in CRE is the most valuable commodity you can have.  The only catch was they needed outdoor space, and in a city that is very hard to come by.  So I started my search.

After a month we found an old auto repair shop that actually would have been perfect, but the seller decided not to sell at the last minute.  That was very disappointing, but it led us to find the next place.

Fast forward to about 4 months after initially connecting with the dog daycare, and we found a great property.  This was a 2000 SF building, one floor, with a large backyard.  It's on a busy retail corridor, so I'm not even sure why they had a backyard to begin with but it's exactly what we needed.  The property was split into 2 stores, I think perhaps illegally by the current owner, but the devising wall could be easily torn down to turn it back into one large open space.

The key to this entire deal was that one of the tenants was on a month-to-month lease, and the other's lease was expiring at the end of June and he did not have the right to renew.  They were both paying way under market rent, and this is why the building was not getting a ton of interest from other buyers.

I contacted the seller of the building and took a tour, and it looked good.  I then called the dog daycare and said come take a look at this building, which they did, and they absolutely loved it.

I then made an offer on the building, contingent on both inspection and financing contingency.  They did not want to agree to either, but I said take it or leave it.  I then negotiated a lease with the dog daycare that was fully contingent on me closing on the building.

For reference, the 2 current tenants were paying around $5000 MG/month combined, and the dog daycare agreed to $7200/month NNN.

I know had a property under contract with a signed lease.

We then had the property inspected, and it turned out the roof needed to be replaced in probably 5 years (if it had come immediate small fixes).  We had a roofing company come out who quoted $60,000, which I knew was high but they were the only one who could come out right away.  

We shared the report with the seller and asked for a credit, and they said NO.  We went back and forth, and they had their own roofers come out who quoted $25,000.  If anyone is familiar with roofers, they are not all created the same, and no matter what they quote you up front they can change once the roof is off of your house LOL.

We went back and forth some more, and they finally agreed to a $21,500 credit.

At this point we had gotten the price down from $983,000 to $961,500.

No lender would have given us a mortgage based on the property the way it was being sold, but they all changed their tune when I handed them the signed dog daycare lease which was for 10 years with 3% yearly increases.

My wife and I own another commercial condo valued around $750,000, and we found a lender that would give us not only the mortgage for the new purchase but also a cash-out refi for the exact amount we needed to pay for the down payment and closing costs for the new purchase.

We closed on both loans last week, the current tenants are out at the end of the month, and the new tenant's lease starts July 1.

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Purchase price:  $961,500

Purchase loan: ~70% LTV. $681,000. 6.5%. Approx $4600/month payment

Cash-out Refi loan:  $280,000 + closing costs = ~$312,000.  6.5%.  Approx $2100/month payment

PURCHASE PROPERTY:  $7200 rent - $4600 loan = +$2600/month (NNN lease so tenant covers all tax, insurance, CAM)

RE-FI PROPERTY:  $4000 rent - $2100 loan = +$1900/month (NNN lease so tenant covers all tax, insurance, CAM)

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Value of property before purchase:  ~$983,000

Value of purchase property after adding in the new tenant based on NOI Valuation formula:
(Property Value = Yearly NOI / Cap Rate)

NOI = $7200/month x 12 months= $86,400
Cap Rate = 6.5% (this is an estimate based on area, property, and lease)

Property Value = $86,400 / .065

Property Value after purchase and new lease = ~$1,329,230.77