All Forum Posts by: Nick L.

@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

@Jarred Sleeth I hear you, it's tricky. While the only "right" answer comes from DCF, here is how I would think about it on a rule of thumb/heuristic basis. 

First, decide how long you want to hold the property. Let's say it's 25 years, which is long enough to pay down a commercial mortgage and still sell to another investor who can get a full term commercial mortgage.

Mentally fast forward 25 years to your sale point. How much (in today's dollars) would a future investor pay for that same property with 42 years left? Don't forget that this future investor is making the same calculation as you are now, and his future investor only gets 17 years. For the sake of discussion, let's say that your future investor would pay $250k in today's dollars because he knows it will be nearly worthless by the time he comes to sell.

Now you have to figure out how much money you have to make over your ownership period for the investment to be worthwhile. I would probably figure I need to make 10% average return on equity before tax, or $50k a year average over the life of the investment. Since I'm going to be selling it for $250k less than I paid for it in today's dollars, I actually need to make $60k per year cash flow in today's dollars. 

Well actually your discount rate (the rate at which you can reinvest profits) is hopefully a lot higher than inflation, so you should tack on a bit... without firing up Excel let's say you need to hit $70k per year cash flow.

Lets tack on a bit for your lost opportunity cost/hurdle rate and say you need to make $80k per year cash flow. That's after leverage of course. Without firing up Excel that's probably about a $60k NOI.

A fair cap rate for the type of shopping center that you describe might be 10-12%. So a conservative estimate might be that you have to purchase the strip mall for about $500K to make the math work, or less to get a good deal.

Funnily enough that's about exactly what the sellers are offering. Of course this is just hand-waving math so I might be off for quite a bit but it sounds like you're in the right ball park. 

If the real/DCF math comes in about the same, you would be doing pretty well at this price and better at anything below it. My guess is that if they cold-approached you at $500k you could get it for $400k.

But hey, I'm 2 glasses of wine down so you should probably review my logic with a critical eye :)

@Jarred Sleeth No problem. I would add that the hairier this situation looks, the better it may be for you. A local strip mall does not typically attract the kind of investor who will be comfortable with a ground lease situation or a DCF calculation. So you will have very limited competition.

Also, the owners clearly like you or they would not have approached you. So my feeling is that you may be able to get this deal at an attractive price.

@Jarred Sleeth Here's a simplified model to show the concept. In this magical world, imagine there is no such thing as inflation or taxes.

Let's say that you can buy a conventional (fee simple) property for $100k cash. You anticipate making $10k per year cashflow and selling the property in 10 years for $150k.  So your total outlay would be $100k, your total income would be $250k and your total profit would be $150k. 

Now compare this to the same property on a ground lease with 10 years left on it. Clearly you won't get any money back at the end of the 10 years, so you need to make your $250k income from the cash flow alone. This means the property needs to return $25k per year over the next 10 years in order to be equivalent to the first model.

Moving from this simplified model to your real life situation, here are some complicating factors:

1. You have to take inflation into account. 

2. Cash flow is taxed differently from capital gains. There are also factors like depreciation sheltering and 1031 exchanges that may affect your calculations.

3. The length of the ground lease is much longer so it would not run to zero. But your selling price would need to be discounted from what a fee simple property would sell for, because the next investor after you will be that many years closer to the end of the ground lease.

4. If you need a lender, you have to adjust the figures to account for leverage and also paid down equity.

With all this in mind, the only true way to figure out the value is with a discounted cash flow model. I would probably start with a handy DCF spreadsheet from BP or elsewhere, and upgrade to a paid REFM model to verify during due diligence.

How many units are in the complex? Would you have a majority share? 

I have the same concerns as @Jamal Okon. If you (and perhaps other investors) own enough units to control the HOA, it might be a good deal. If you are at the mercy of a regular homeowner-controlled HOA I would be much more skeptical.

@Alan Modracek

Aside from Google, try your local REIA. Or ask around at banks - a lot of loan officers have private lenders that they refer deals to.

I'd very much like to meet up with you but just can't do it tonight. Enjoy the city!

@Mark Creason is right. Milwaukee is a big drinking city and people still flock to the bars in the middle of winter. In fact, sometimes it feels like that's the only activity! And yes there is a dock for customers to moor boats in the summer, and other attractions such as volleyball courts.

Based on @Joel Owens's comments and other valuations, it looks like you would have to see stabilized gross annual sales of $3m+. Unfortunately my only experience of bars and resataurants is as a patron so I'm not sure how feasible that is. To @dan wallace's point, I would need to bring in a very experienced restauranteur.

@Joel Owens

Thanks for replying. I know you have a background in restaurants as well as commercial RE.

The local median income is misleading. The property is in an old industrial area with many factories and warehouses bordering the river. But the adjacent neighborhood to the east is a big bar/restaurant area that attracts millennials with high disposable income. Also, the property's riverfront location and boat docks attract higher income people from across the metro. So the catchment area is better than the demographics imply.

You make a great point about national comps. I was only thinking locally. If you were to value the property on an asset basis against other similar properties, where would you peg its value?