1st Commercial Property - Posted by Doug

Posted by Doug on May 27, 2006 at 13:39:53:

Side note—the financed amount is $230000 to include a buildout of the spa.

1st Commercial Property - Posted by Doug

Posted by Doug on May 27, 2006 at 13:32:55:

Hi Ray, I am a physician in the very beginning of a real estate career. I am under contract for two adjoining buildings (combined 4000sqft)on a small town square. The price is $195,000. There are two tenants in 1 of the buildings with rents combined at $900/month. We are about to build out the remaining 2000sqft and open a health spa. I am a partner of the spa. My LLC will hold the note on the property with the spa paying the $1000 balance in rent. Terms on the building are–Zero down, 8% fixed–20year mortgage. Payment approx. 1900/mo. Can you think of any “outs” I may need to include in our organization contract with the spa to better protect myself?
Thanks, Doug

Re: 1st Commercial Property - Posted by ray@lcorn

Posted by ray@lcorn on May 30, 2006 at 19:19:39:

Hi Doug,

You may have to help me out here… the “I”, “we” and “our” is confusing so I’m not sure who is doing what.

I’m assuming you own the Building LLC? And assuming further, the Spa Partnership has partners in it not in the Building LLC?

Assuming that’s the case, your Building LLC is borrowing enough money to finance the purchase of the buildings ($195,000) and the improvements for the Spa ($35,000)?

Then you’re going to lease out the spa space for $1000. Total income for the two buildings is then $1900, which is about the payment on the acquisition/improvement loan.

That means all other expenses (e.g. property taxes, insurance, maintenance, etc.) are out of pocket for the Building LLC, also known as negative cash flow.

If it were me, I would price the rent to the Spa at a rate that would at least cover the operating expenses and a modest rate of return to the Building LLC. I would also craft the normal landlord protections as with an arms-length tenant, such as a “go-dark” default clause (all lease payments due and payable if dark >30-60 days), a provision for CAM charges (e.g. property tax, insurance, maintenance. etc.) to make it a triple-net lease. Think of it this way… write the lease as if you are planning to sell the building, as that could be a necessary exit strategy. So anything an unrelated buyer would want to see in the lease (normal market terms) would be appropriate and advantageous.

But then you have to take off the building owner hat and be a partner in the spa. I might craft cross-default clauses between the lease and the operating conditions for the partnership. In keeping with the 3rd party sale exit strategy, that’s the place to protect yourself in the event things don’t go well.

But everything depends on the specifics of the relationship of the partners; e.g. number, respective capital contributions, management participation, etc. As an investor I might dream up a boatload of control measures that may be appropriate in the partnership agreement.

Ultimate goal would be if the thing turns south I would want to be in control of my investment(s) quickly. That may mean short notice periods, performance pegs, profit-sharing, etc. But really it’s hard to be specific without knowing a whole lot more.