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!