Hopefully, my last post gave you the numbers, and today’s will explain the ‘deal’:
So, here is the crux of the deal:
1. I have a property with one good tenant (they are cashed up … because I just gave them the cash!) and an easily rentable smaller area for a second tenant.
2. If I borrow 75% at 6.5% fixed for 7 years, I get $63,000 cash (i.e. TOTAL INCOME – TOTAL EXPENSES) in Year 1 to spend (well, keep some in reserve against future repairs, vacancies, etc.).
3. My deposit is $700,000 so that $63,000 is a 9% return on my own money (subject to those unforeseen costs that I mentioned in 2.) … not a bad return on cash AND I get all the upside on the property.
4. If the second tenancy is vacant for any reason, I still almost break-even.
5. If the second tenancy rents at only $6 / sq. foot I still net $43k per year; if I get $10 / sq. foot I net $83k.
6. Properties in this area sold for $80k – $120k per sq. foot; even though the market has softened somewhat (commercial generally works on a slower up/down cycle than residential) I am buying it for $60 / sq. foot … clearly, if a condo. developer knocks on my door in 7 years and offers me $120 / sq. foot, I’ve doubled the whole $2.6 Mill. (not incl. Realtor’s commissions) purchase price!
Note: Think about that – when people say that RE only increases with inflation, therefore stocks are a better option: I make $63k a year less costs (est. 25% as a contingency), say, 6.75% net. The property then increases to $3.4 Mill. over the next 7 years (that’s only inflation):
I earn: $362k in rents (after the 25% contingency against, repairs, and with a 3% rent increase each year)
plus: I net $700k on the sale of the property (I’m expecting to make close to double that, but let’s just accept inflation for now).
I return: That’s a total of $1.362 against the $700,000 that I put in (the bank put up the rest, and they’ve already been paid interest and their money back in these numbers) or 11.5% on my money
I expect: But, that’s only if the building appreciates by inflation; I expect to net at least $1.5 Mill. on the sale of the property (if not $2.5 Mill.!) which brings the return up to 20% … secured by real-estate, no less!
7. If no purchaser does come along, I am earning a neat 9%+ on my $700k until somebody does buy it!
So, by all measures, this is a great deal … some common sense and some simple number-crunching tells me that, no ‘cap rates’, ‘proforma’s, or any other complex financial manipulations necessary.
BTW: I did a quick ‘drive by’ but haven’t even been inside, yet. It doesn’t matter … I won’t be ‘living there’ 🙂
Next step: tell the broker to make the offer!
Looks like a winner to me!
Do you always qualify the RE investment by the yield first then only followed by the appreciation aspect? Thanks.
@ Scott – Might explain why the current owner/occupiers are doing their best to try and hang on to the property!
@ Bill – You should always INVEST in income rather than SPECULATE on appreciation … the good news is that if you aim for the former, you will probably also end up with the latter 🙂
Well I have read ,that You don’t make your money on the sale of property.You actually make your money on the purchase.:) Seems to me , you just made your money.I like the 9% a year(this is very difficult to find during times like these. I also like the nice return you will be expecting on the other end(sale).
Now , just 1 suggestion for those seeking properties. Since we cannot always count on inflation taking the price higher, it might be best to try to locate properties that sit in front of construction(meaning you check with building records to determine which direction the city has been expanding into). You locate properties out a short distance in front of the planned building. This will almost certainly assure you will have someone in a few years knocking on your door interested in the property you have.
Anywho, congratulations Adrian,hope all goes as planed for your new property. 🙂
@ Steve – good advice; I read a book by a very successful residential property investor (STRICTLY buy/hold) who always looked for announced new developments (e.g. marinas) and bought residential real-estate around that area … he said the residential property always went up, but that commercial property in/around these developments was more ‘hit and miss’ …
… my message on property is clear: treat it as a business; see my comment on Andee Sellman’s blog:
Hi I’ve followed your site for the past months and I love all the advices you’re sharing with the public. I have a question about this particular real estate you’re about to invest. Do you find it a little bit risky to lease it back to the (former)owner of the property since if their business is sounded they wouldn’t have to sell the property in the first place?what would you do if they decide to walk away after a few months?I see business who did not do well walk away from the lease and vanished from the face of the earth. Just want your opinion on that and how you deal with run away tenant.
@ Angela – I’m glad that you have been reading and decided to jump in with a comment … it’s what makes this site ‘tick’ … keep it up!
As to the risk of tenant departure, that’s probably a huge issue with any commercial property: you are usually less ‘tenant diversified’ than in, say a multi-unit residential where you may have 10, 20 or even 100 tenants at the same purchase price as a single (or, in this case 2 or 3) tenant commercial property.
There’s one difference b/w my former-owner-occupier tenant and the ‘random’ tenants that I would otherwise get: they are cashed up … I just ‘gave’ them $2.5 Million! The very fact that they are struggling to keep the building rather than sell to me, tells me that they don’t need a lot of extra capital to keep going, and, maybe I’ll just make them bond some of the rest (or provide a bank guarantee).
Great question tho’ … and, one that I have been thinking of strategies to handle myself … any other ideas, anyone?
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You mentioned 63k income that you can spend, but I don’t see you including principle payments. Wouldn’t that cut into your cash flow?
@ Drew: The building will generate $255k in rents – $192k in expenses (including $130k bank interest) = $63k net ‘profit’ p.a.
Principal payments don’t make the deal better or worse … which is why I would recommend going Interest Only (to protect that cashflow that you mention).
I have recently started reading your blog and have found it quite interesting.
Continuing with the comment from the previous reader, can you elaborate a bit more on why principal payments would not affect this deal? On the previous article you mentioned going for a 7yr financing or so, which will represent about 250-300k of additional capital you need to put each year. After the first year you would have invested 700 + principal (let’s say 250k) = 950k. The 63k you make then will become a 6.6% return on your own money… Then down to 5% the next year… And so on…
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