Julie’s commercial real estate training
SEATTLE IN VESTORS CLUB
Commercial Real Estate Investing
November 8, 2014
Different Types of Real Estate Assets
You can download this handout by clicking here or simply read below.
- Residential / SFR / Condos / Townhouses / 1 – 4 Apt Units
- Multifamily / 5+ Apartment Units
- Office / Different uses – Professional / Creative / Medical/Dental
- Retail / Stand Alone / Strip Centers / Shopping Malls
- Mixed Use / Retail or Office on bottom apts or office on top
- Industrial / Light Industrial / Heavy Industrial / Yards
- Mobile Homes – Will have this topic on the 2015 meeting schedule!!
- Land for Development / Single Family / Apts / Office / Retail – Look first at zoning
How to Find Commercial RE Opportunities
- Look for vacant and/or poorly managed properties – send the owner a letter and/or call them
- Always check the zoning on ALL properties first thing, including residential properties. Identify properties in which the zoning is not being used to its “highest and best use”. In King County, look for RSL zoning, LR zoning, NC zoning or C zoning – then call Julie for help
- Pull a list of apartment properties through your title company and mail the owner a letter or postcard – say pull all the apartment projects in these zip codes that are 20 units and under that have been owned for at least “X” years or longer
- Review the NWMLS, CBA, Loopnet or Redfin for properties with high vacancy or long days on market
- Join local Rotary clubs in submarkets that interest you – network with local landlords
- Network with apt & commercial brokers – ask them to call you on all seller financed opportunities or “value add” opportunities
- Put out bandit signs that say WE BUY APTS -10 UNITS AND UNDER
- Call landlords off craigslist or rentalsource.com offering apts for rent and ask them if they would consider selling – call on ones where the asking rent looks below market
- Call property management companies and tell them you are a local investor looking to buy more apartment units (you and your partners) – if one of their clients has considered selling to please let you know. You would be happy to let them continue managing the property if you buy it………
- Run a short ad in a local community newspaper saying Apts Wanted – To Purchase
How to Identify a Potential Commercial or Multifamily Deal Worthy of Your Time
- Can your raise rents immediately or during the next 12 months on all or some of the units, after making improvements? Can you raise them without making improvements = passive landlord?
- Is it a high vacancy or poorly managed, deferred maintenance property?
- Is there an opportunity to convert apt to for sale product = condos? LOTS OF RISK & reward.
- Is there a loan maturing on the property that was put on in 2004 – 2006? Pay down loan req’d?
- Are there leases expiring (office or retail) that will create high vacancy in the next 12 – 24 months and therefore require large expense to do tenant improvements for a new tenant plus pay leasing commissions – or is expiring at a bad time, for example matching up when their loan is maturing?
- Is the existing layout of the building, spaces or units not functional and you can change it to attract a new tenant? Can you add more units or rentable space to the existing property?
- Is seller financing available? Call Julie for strategies and calculations to help them say “yes”
- Can you create value on under-utilized zoning through entitlements = permitting?
- You are looking for VALUE ADD opportunities through 1) raising rents or 2) maximizing the properties “highest and best use” based on the existing zoning. Zoning “variances” a very difficult to get – don’t bother spending time trying to do that.
Investment Goals & Strategies
- Strategy: Make cosmetic improvements, raise rents, stabilize property, sell it or pull your equity back out through refinancing it and holding it longer term. To create true wealth – you want to hold long term
- Goals: Maximize monthly cash flow, create upside market value through improvements or entitlements, have as little cash left in the deal as possible and collect consistent monthly cash flow. (Entitlements are approved Permits/Plans that now make a property “shovel ready”.)
Cash on Cash Return = annual net cash flow / amount of cash (equity) you have in the deal. In very desirable locations (near urban villages), investors will accept between 4% – 5% return. This level of return is more of a “park” your money return because you have extra cash and/or believe the neighborhood will continue to gain value. The further you get out to the burbs, the higher this acceptable return will be, generally speaking. Typical hedge fund returns are approx. 8% – 9%. If you can get 10% or higher cash on cash return = great deal!
Decide what is acceptable to you personally and make sure you have cash reserves for upticks in vacancy, for capital expense type of repairs. Know your break even before you buy. Always have a budget & exit plan.
Side Note – if anyone can put together a buyers list for rental property owners that will accept 5% – 8% cash on cash returns, that is a goldmine! Go for it!!!
Secondary Goal: Hire a property manager – do not manage it yourself – poor use of time.
Third Goal – payoff smaller properties and own them free & clear = STELLAR retirement income.
Buy from or partner with seller on properties with under-utilized zoning, pay to take it through entitlements. Profit = mass value created here…then sell it with entitlements in place. There are 2 different categories of commercial developers. Those that build and those that do not. Lots of “developers” never actually build the projects they buy. They buy them, entitle them and then sell them to other developers who build. Typically the builder that builds has already pre-sold the finished project to a new end buyer – a national REIT or other “institutional” investor.
Must Do’s (And 1 Don’t) – PRIOR to Your Purchase
- #1 – ALWAYS, ALWAYS KNOW YOUR EXIT STRATEGIES BEFORE YOU PURCHASE A PROPERTY
- Prepare your rehab / lease up budget as well as your stabilized budget, including your future loan payment goals, BEFORE you buy the property. Check debt service coverage ratios that might limit you loan amount.
- Call local apt or office brokers or better yet appraisers, and ask them what the “cap rate” is for a property like the one you are looking at in the same location.
Cap rates drive what the market value of the property is: Net Operating Income / Cap Rate = Market Value
Market Value x 70% = Loan Amount and this is double checked against Debt Service Coverage Ratio / 1.25%
DSC = Annual Loan Payment (P&I) x 1.25%. This number must be HIGHER or equal to your annual NOI
NOI = Net Operating Income, including capital expenses, before debt payment
- Identify a conservative break even budget for the property so you know your downside risk BEFORE you purchase the property. If you had 15% vacancy, could you make your loan payment?
- Understand how the banks underwrite for their apt loans so you can PRE-underwrite your stabilized loan amount goals BEFORE you purchase the property. Banks do not use 3% for vacancy loss. Banks do not project rents. Banks limit loan amount to approximately 1.25% debt service coverage ratio…and so on.
- Decide what your personal minimum amount of monthly cash flow is acceptable to move forward on a deal and make sure that underwrites to be achievable
- Decide what your personal minimum upside in market value is that is acceptable if you sell after you execute your plan.
- Don’t get emotional about your purchase – let the numbers tell you if the deal works or not.
So….You think you found a deal worth going after…NOW WHAT?
Questions to ask the Seller as a quick assessment of the opportunity
- How much rent do you currently get for a studio, a 1 bedroom, a 2bedroom (1 or 2 bathrooms?), a 3 bedroom?
- Is the property fully occupied or are some units (or spaces) vacant?
- #1 Are the leases MTM or are the tenants on 1 year leases? You want them to say MTM = ideal situation. Why? It allows you to move forward and execute your value add plan sooner.
- Have any of the units been upgraded? Yes, what was done? Any other upgrades to building = roof, windows. Do you have any photos you can send me of the units from one of your last leasing ads?
- Do the units have dishwashers?
- Do the units have w/dryers or any hook-ups? No, is there a space to put them in?
- Is there a garage or what is the parking situation for the tenants? Is there a parking fee – how much?
- Do the tenants pay for water/sewer/garbage or do you pay that?
- Is there normal turnover of the units or have the current tenants lived there a long time?
- Are there any capital improvements that need to take place during the next 5 years?
- How do you normally find new tenants – source of rental?….craigslist ad or something else?
- Do you own the property free & clear or is there a loan on it?
- If free & clear, would you consider any seller financing? Either way is OK with me, but I always ask.
- For office/retail – are any of the leases expiring in the next 24 months? Yes, do you expect them to want to renew their lease? Do you know if any of the existing tenants would want to expand?
Deal Analyzer – called a Proforma in Commercial RE
- See hand-out
Due Diligence Checklist – Info to Gather once You Are Under Contract = Inspection Period
- Current Rent Roll including lease expiration dates or get a separate Lease Expiration Report
- Most recent year end 12-month Income & Expense statement (as of 12/31/13)
- Current Year –to-date Income & Expense statement (broken down by month and summarized if they have)
- List of tenant security deposits (Is part of what you originally collected non-refundable?)
- List of capital expenditures over past 5 years
- List of all contracts (landscaping, elevator contract, HVAC service contract, advertising, laundry room equipment lease – anything else?)
- Copy of all leases
- GO THROUGH all the leases and make sure if it says they had a security deposit that it is showing as a deposit on the security deposit report.
- List of any tenants with delinquent rent – and how much, by month
- List of any tenants with prepaid rent – and how much
What to Look for on Unit Inspections – Walk all the units prior to your purchase
- Look up! For water stains on ceiling, etc
- Use a unit walk sheet – per unit / note unit type & unit number (1×1, #202). Make notes on condition so you can properly budget repairs or rehab. Not just cost, but also timing of when you will have to spend the $$$.
- Check the roof
- Check windows for leaks or broken seals
- Check all decks for rot, drainage and/or railing issues – Look up! See deck above you.
- Are there ceiling fans? If not, how to ventilate bathrooms
- Look for washer/dryers or place to add them – ideally unit types need to be “stacked” to easily add them
- Confirm all appliances are there in each unit
- Check condition of flooring – so you can budget when replacement is needed
- Check elevator service log and any mechanical service log for date of last service
- Check if units have smoke detectors and CO devices
- Check fire extinguisher tags in hallways to make sure tested and up to date
- Look in closets for hot water tanks – how old?
- Look to see if any furniture pushed up against baseboard heaters = fire hazard
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