All Forum Posts by: Henri Meli

@Michael McCoy . Thanks and great question. I'm still thinking about what my next move should be. I could do a cash-out refinance, but I can also see if I can find a buyer, since the building is now stabilized. As of today, we are still creating value in the building as well as addressing deferred maintenance items. 

Personally (and I have numbers to back it up), I believe there is still another $500k in value I can "produce" from this building in the next 2-3 years, IF market conditions mirror what we have seen recently. BUT, that is a big IF . Another  question I have been asking myself is, if there is another investment I could make that would produce me similar returns, if I decided to sell.  I have also been wondering about my own risk tolerance ... given the run our economy has been in the last 8+ years.  

@Dante Pirouz  . Thanks and great question. The bank told me they would not finance more than $1M. So, I have to come up with the rest. I didn't have any money aside for reserves. I explained in the previous response how I scratched money together for the work needed. The property was cash flowing from day 1. 

@Tracey Fergerson . Thanks. And great question about the money for  improvements.

I have to admit, this is one of the areas I didn't plan well. I did whatever I needed to do to find money.  

0. The property was cash flowing from day 1, so there was no concern making monthly mortgage payments. 

1. I advised the PM company to only address absolutely necessary issues that came up at the property. If the issue wasn't necessary, we would defer it. And we made sure it was communicated to the tenants.

2. I asked the contractors working on the projects to break down payments over many months, which many did.

3. I continued to scratch pennies anywhere I could (tax refund, credit cards,... etc). 

After 8 months, I sat down with the bank and showed them the numbers, which they liked.  They opened an interest only line of credit. This was really to give me breathing room. The heavy lifting was done by then and most of the debt was paid back.

@Elliot B. . Thanks. Yes, value-add is really a good concept to grasp. I recommend lots of people to really understand it well. It helps you see value (money) where others don't and can play to your advantage.

@David Park  I just wrote a report here that describes my journey into Commercial Real estate.

I started with Residential as it is easier to understand. Easier to get a loan. And Easier to find tenants. It took me years to scale up into commercial, but looking back, I wish I had scaled up earlier.

The Value-Add concept is something I really advice lots of investors to understand as soon as possible. 

My RE Success story. Thanks Biggerpocket.com community for the inspiration and guidance. I posted this in the commercial real estate forum as well. Not sure how to cross post (if even possible). Reposting it here.  

I made my first real estate investment by house hacking a 3 Bedroom townhouse more than a decade ago.
After closing on my 4th single family rental, I started looking to scale into multi-family apartments. I couldn’t find any assets that met my buy criteria in my targeted zip code. My commercial broker suggested I look into other types of commercial real estate assets such as office, retail, mobile homes, storage, …etc. I was skeptical at first. But after losing on my n-th multi-family bid, I decided to take a much closer look at office buildings.
I spent lots of time on this site researching how to evaluate various commercial assets and specifically how to effectively implement value-add strategies. Thanks to the input from savvy investors , I fell comfortable with the idea of owning a value-add office building. In the summer of 2016, my broker presented me with a 17,500sf building in Raleigh, NC. It was being offered at $1,450 millions.

After some back and forth, I settled with the seller on a $1,350 million purchase price. I had never owned such a large asset before. However, thanks to biggerpockets.com, I had a plan in mind (and written down):

Reposition. Boost income. Reduce expenses. Convince good tenants to commit to longer term leases.

So in the fall of 2016 I took the plunge and closed on this massive purchase !!!

The Asset

The asset was a “typical value-add”. The owner had passed and the children inherited the property, but were not well versed on how to manage it efficiently. The curb appeal was really poor. Minimal landscaping was done. Rules and regulations were not enforced and there were broken down cars in the parking lot. Ownership had stopped performing necessary maintenance. No wonder, good tenants had left. Many leases were under market, year to year or month to month. About 70% of the building was leased, when I put the building under contract.

The Numbers

Getting a bank to finance the loan was a challenge. After a large number of denials, I finally found a bank willing to finance the purchase of the asset. I got a $1M recourse loan, 4.5%, 5 year fixed, 20 year amortization.
I won't mention the "purchase CAP Rate", because this number can be really misleading. Why? Although lease income as well as tax rate and insurance can be verified, Owners can write whatever they want in many expense columns. I focused on the potential income I could add and if I could keep the expenses around a certain percentage of income, then I had enough meat on the bones to make the deal

Asset Repositioning

After closing, one of my first moves was to let go of the current property management as they didn’t align well with my vision, my plan and my execution strategy. After multiple interviews, I settled on a smaller local PM that was willing to work with me hand in hand. I had a leasing agent, who worked with me through the purchase process and was extremely useful. I continued the repositioning by improving the externals of the building. Doing simple commonsense things made a big difference in the curb appeal: Trimming trees, installing new mulch, power washing the building, cleanup the parking area, common areas and trash area, installing parking violation, … etc. Then I worked on improving and actively enforcing the rules and regulations: Trash all over the place, smoking in building, dumpster, parking at the property was just wild and even dangerous.
Simultaneously I tackled deferred maintenance items. Many HVACs had reached end of life. The roof had leaking issues in many places. Additionally, late fees were strictly enforced. Offices with nicer views leased at a higher square footage price, tenant on short term lease (1 year) were asked much to pay higher sf prices. My leasing agent and I worked hard to get the building leased out. And by month 6 of ownership, we were 95% leased. Finally, in May (18 months into ownership), the building was 100% leased. With the exception of one tenant, all tenants are on multi-year leases.

The new building value
The new tenants income combined with the lease adjustments and rent escalations added close to $90k in new revenues from the time I made my offer to purchase.

An appraisal requested recently valued the building at roughly $2.1M, which is $750k above the purchase price.

However, I’m not yet done as there is still plenty of value to be extracted from this building. This is where the second part of the strategy comes in play.

Expense reductionThe building tax value was $1.9M at time of purchase. I filed with the county to have the tax basis match the acquisition price and it was approved recently, saving me roughly $5,000 in this year tax bill. In addition, all leases are full service, meaning owner pays all utilities and taxes, insurance ⦠etc. An assessment showed, we could reduce it by roughly 40-50% with little investment. RUBS couldn't be implemented because of existing leases, so I went another route. All lightbulbs have now been replaced with LEDs, Photo cells have replaced timers, motion sensors have been added to all offices. In addition, we are taking advantage of a program offered by the local energy company to install Smart Thermostats in the building at no costs. Furthermore, as we replace older HVAC (expected Capex expense) with new ones, we are gaining more energy efficiency and lower utility costs.
Water conserving fixtures will be installed early next year. All the new gears should significantly reduce maintenance costs and overall utility costs.

NOI (Net Operating Income) Boost
Combining the tax savings, utility cost reduction, maintenance costs savings and lease escalation (up to 6%), the NOIboost is expected to be roughly $30k by the middle of next year when all leases turnover. At an typical 8 CAP, that's a value-add of $375k.

That’s like adding a new tenant at no cost !!! That’s the power of Value-add investing!!!

What I have learned so far?

Here some of the top 3 take aways from investing in this asset class.

Pros

• Yearly lease escalations is really nice.
• The tenant base is more sophisticated.
• Persistence in a good trait to have.
• Having a good team makes a big difference.

Cons

• It costs money to bring in new tenants
• The competition has lots of capital, but nothing beats knowing your turf very well
• Always read the details of leases (the tenant base is quite sophisticated)

@Howard Yang . Welcome on board and make sure to take action and surround yourself regularly with like-minded in the online community as well as in real life. Those are critical to your success. 

@Greg Raymond If real estate is your passion, you are better off spending time with people who will reinforce and encourage you in the right direction. People who are actually doing it. Your family might not have enough knowledge to give you advice or way or another. 

Let me give you a couple of strategies that have been used to improve cashflow (or even the value of a property). But these strategies are location specific and depend on the experience of the operator/operating team.

If your property is in an excellent location(let's say a location that sees lots of out of town traffic), you could always turn a few of the rentals into short term rentals. If done right, you could double your cashflow for these units. 

Imagine you could do that. Would you offer more than what you offered? Sometimes raw numbers don't tell the whole story. As a value-add investor, you could think outside the box and always come up with scenarios that could justify purchasing an asset higher than the average investor. 

Just something to chew on !!!

Congratulations on taking action.

Interesting case study. Schedule E has information provided to IRS. Seller better be accurate. 

Here are my 2 cents, based on my experience however. 

First, I would calculate the actual occupancy rate on the property. 37,600 (actual)/58,800 (expected). 63%. And compare that with the actual occupancy rate in the area. You can also reverse it and look at the vacancy rate.

Second try to understand if it is typical or just a poorly managed building. If this is typical, I wouldn't bother. If this is due to poor management, I would definitely make an offer and have a solid plan in place on how to fill the place realistically within a reasonable amount of time. Note that raising rents is not the only way to add value to an asset. There are lots of other ways. Some will depend on the asset type (class C,D?), location and the manager's experience. 

What hold time do you give yourself? At what cap rate do you expect to exit/refinance the asset?

Good Luck.