Author Topic: Commercial Property -- Opportunity or Bust?  (Read 2457 times)

smedleyb

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Commercial Property -- Opportunity or Bust?
« on: May 25, 2012, 04:47:54 PM »
I recently came upon a fascinating opportunity to acquire a piece of a century old textile plant -- brick construction, three floors, 42K square footage, building underwent extensive renovations in early 80's, updated electric, sprinklers.  It's a solid building even if it is a bit old and dated in some parts.

Turns out my friend has diligently worked his way into a 20% ownership stake in the building; he opened an office on the 3rd floor 5 years ago -- the only guy there at the time -- and since then has worked (not too hard) to bring in other tenants.  Well those other tenants have created enough rent to  pay the building's fixed costs -- which includes a full time employee who takes care of the building (but I don't think he's vital to the day to day operations).  Well, his other partners in the building are old and want out -- probably because the building has been a money pit for years.

In short, we think the building is available for 300K, but there are two debts outstanding at 30K and 25K.  We also think we can negotiate one of those debts away, making the purchase price around 290K plus around 25K in debt.  The building's costs are around 95K a year, with heat comprising about 50% of that!  Rent for the year came to around 97K, leaving 2K extra -- on paper.  But buildouts for new commercial space will take some capital.  Yet the cool part of this building is that it is what it is -- an old textile plant -- and the spaces we create do not resemble the homogeneous office/retail space you get downtown. 

The opportunity?  Five years ago, my friend had no money and the building was losing thousands a month.  Today he's got a 20% stake and the rents pretty much cover the operating expenses -- for now.  Only half the building is rented, yet we know that with a little more aggressive marketing, was can get another $2000-3000 a month in rents per month over the next 6 -12 months.  Also, the prospect exists to raise rents around 10%, thereby boosting rent another 10K a year.  We think firing the sole employee and contracting out his work would save another 10K a year.  That's around 40-50K in new cash flow, with another 40% of the building still empty and available for rent.  We think the owners would take 25% up front, then carry a note at around 5% for 10 years on the balance.  Paying them takes 21-22K out of our yearly cash flow, but nearly 14k of that is principal.   

On the  flip side, this is a huge building with massive monthly bills.  (Along these lines, one of the tenants in the building converted the boiler to burn on recycled fryer grease, which has cut energy costs by 30%, but which also supplies this cool upstart green company with the majority of its revenues.  In fact the 25K debt mentioned above is owed to this tenant who is getting paid out 5K a month an will be owed 25K when the time comes to actually hammer out the deal next month.  We're thinking of bringing him in on the building, foregoing his money for a 10% stake in the building.)  The main renter is a company that occupies 25% of the space, spends 3K a month on rent -- the biggest tenant by far, yet there is no telling how long that operation will survive (although it continues to survive year after year).   Not to mention, it's an old and huge building.  I want to get an engineer in there to do a detailed study but it will cost some pretty bucks.  Yet a roof replacement is a 200K proposition with this structure (although the roof was replaced 30 years ago after a storm ripped the old one off!)

My role in all this?  Look to bring 35k, along with another investor who will bring 35K, for a 30% stake in the building.  My friend -- whose contribution will be his 20% stake valued at round 50K -- takes 40%.  The two building partners, whose stake we are buying out (290K - friends 20% stake = 232K.  Pay them cash for 25%, or around 60K.  That leaves roughly 170K financed at 5% for 10 years, or around 22K a year.  But of course there is that 25K energy debt, which we will pay off by providing an equity stake, thus it leaves us at 36%, 27%, 27%, and 10%, 170K in debt, and on the path to generating 2K a month in free cash flow (after mort. payments) and another $1200 a month in principal payoff.  Of course we will leave all extra money in the building for debt payment/improvements and look to boost our rents over time.  I think 15K a month in rents  -- or double current rent income -- is within the realm of possibility over the next 3 years (given we rent the spaces at half of what you can get in our old, small, rust belty town). 

On my angle, I'm thinking of taping my home equity to get the cash to make this happen.  Even though I have the cash available, I'm thinking of refinancing the house (value 275K, owe 135K 12 years left at 3.75) for 200K over 30 years at 3.85%, around 4K closing costs, and taking that 60K cash out and putting half into the textile building and holding back the other half for other RE opportunities which may come my way.  I thought about HELOC but the thought of borrowing 200K at sub 4% for 30 years seems like an interesting bet I wanna make.  Nobody else will loan me that much that long ever again!  Or so I think...

This is a rough schema of what's before me.  I would appreciate any and all advice from our RE experts!





« Last Edit: May 25, 2012, 04:51:39 PM by smedleyb »

Ipodius

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Re: Commercial Property -- Opportunity or Bust?
« Reply #1 on: May 28, 2012, 03:19:00 AM »
I'm by no means a property expert, and I live in a different country, so take that into account when reading my advice :)

Having said that, wow, this looks complicated, speculative, and it looks like you could lose *a lot* of money if something goes wrong. Considering the opportunities available in the US property market at the moment (foreclosed properties that can be cash flow positive after spending $20k fixing them up), I'd rather go for something like that.

What real estate investments do you already have, if any? Something like this might make sense (from a diversification, enjoyment and possible returns point of view) if you already have other real estate investments / other investments, and could afford to pay the loan for a period without tenants / with major expenses. 

smedleyb

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Re: Commercial Property -- Opportunity or Bust?
« Reply #2 on: June 04, 2012, 05:26:19 PM »
I'm by no means a property expert, and I live in a different country, so take that into account when reading my advice :)

Having said that, wow, this looks complicated, speculative, and it looks like you could lose *a lot* of money if something goes wrong. Considering the opportunities available in the US property market at the moment (foreclosed properties that can be cash flow positive after spending $20k fixing them up), I'd rather go for something like that.

What real estate investments do you already have, if any? Something like this might make sense (from a diversification, enjoyment and possible returns point of view) if you already have other real estate investments / other investments, and could afford to pay the loan for a period without tenants / with major expenses.

I hear you Ipodius.  Since the deal is cash flow neutral, and since there are 4 partners, my buddy and I haven't pursued it much further other than discussing possible investors in the area who might buy the building and cash out my friend's equity stake.

That is, until he met with a potential client today who might need to rent up to half of the available space for the next 3 years which would make the building cash flow positive immediately, perhaps to the tune of 2K-3.5 a month.  Not to mention one of the main investors is pulling out -- the deal is once again front and center in my life with better cash flow and fewer partners. 

As far as other real estate goes, I do own some commercial lots and my primary residence.  But I think there is tremendous value here waiting to be unlocked.  My wheels can't stop turning tonight...