I got an option on a COMMERCIAL building. What can I do to flip it? - Posted by Justin-IL

Posted by Eric C on April 03, 2000 at 15:23:20:

What I meant was I sell the biz to the corporate parent and keep the RE.

See what I mean, Ray, about getting both my mind and my fingers back on-line at the same time?


Eric C

I got an option on a COMMERCIAL building. What can I do to flip it? - Posted by Justin-IL

Posted by Justin-IL on April 02, 2000 at 19:37:56:

I’ve got an option on a commercial property, it’s only about 1000 square feet (3 rooms + a bathroom). Option price of 47K. Will be pulling comps on it tomorrow, my estimate of value is around 60K.

Anyways, I’m real cool with the guy who owns it, I met him at an e-commerce seminar and told him I’d market it on the web. He’s willing to go 2 or 3 months on an option.

I want to market it and sell as quickly as possible. I’ve thought about offering owner financing and selling the note, would this be feasible on a commercial property? This place could be an office, a hair salon, etc.

What would be the best way of doing this deal?



Re: I got an option on a COMMERCIAL building. What can I do to flip it? - Posted by Eric C

Posted by Eric C on April 03, 2000 at 12:31:19:

Hi there Justin -

Please read everything in Ray’s post below. Commercial RE does indeed have a “life” of it’s own, especially when compared to SFH’s.

In an ealier incarnation, I used to “arrange” package deals for large REIT’s. What I was doing is exactly what Ray outlines in his post.

Signing good, high quality tenants can bring tremendous value (read this as lucrative)not only to the property but can also furnish liquidity as well.

For example, say I have twenty buildings across the country (all free standing)with 5 year leases packaged with 2 five year options (pretty standard). These are are currently occupied by a large national restaurant chain. This package would be highly liquid - in fact, it would be as marketable as notes.

On the other hand, if these buildings had individual tenants, say Mom and Pops, the value of each lease would have to be negotiated (and negotiated, and negotiated,…) You get the idea. It would also be almost impossible (well, much more difficult)to find a single “exit” source for funding, resale, or whatever.

The value is in the income stream. That’s sometimes a hard concept to get across to folks who usually deal in residential RE.

By the way, a great tenant is often a division of your state or local government. The normal lease with a gov’t entity (at least, in my experience) is 20 years. Banks (and other investors) love to finance deals that have long-term gov’t tenants.

ADA regulations (and the subsequent compliance issues) are forcing many of those same gov’t tenants to move to new space for the first time in years. A great opportunity!

One more thing, because the nature of the asset is different, there are also some different risk factors that you may want to consider should you do very many of these.

Hope this helps,

Eric C

Re: I got an option on a COMMERCIAL building. What can I do to flip it? - Posted by ray@lcorn

Posted by ray@lcorn on April 03, 2000 at 24:18:24:


There are several ways to play a deal like this, but a pure flip is usally unlikely. Commercial property has a different life when it comes to what creates value for the user. What motivates the commercial buyer is different than the residential buyer. In the first place, a commercial buyer that needs owner financing for his business better have a strong business if I am going to carry his note.

Owner financing in many cases would not at all appeal to the user that could pay the highest cost for commercial space. A retail sales operation that did what they do well, and have no desire to own real estate, will often pay much more than the business that wants cheap space. The trick in commercial real estate is to figure out a way to give the best user a way to get the space.

The way I would approach a deal like you described would be to evaluate the potential upside of the property by using a valuation based on its potential income stream, and make a decision whether to buy and hold or employ some other exit strategy based on that upside potential. You should look around the neighborhood and evaluate what kind of business is NOT there, or a business that could do a better job than the ones that are present. That is your prospect list for renting the space.

The best opportunity in small, neighborhood commercial real estate is usually to buy at or below replacement cost, then improve or convert the property’s use with a new tenant. This creates an income stream, thereby creating value. You then sell or refinance from value based on the income stream to extract your equity and the first installment of your profit. The deal can usually be structured to provide monthly cash flow and a one to three year exit for your equity. You don’t say if this is a freestanding building, or what type of neighborhood it is located in, or market conditions. Therefore my comments will be limited to general conditions.

In my market, neighborhood type commercial property rental rates average $7-$8 per sq., ft. (annual rent). On your building (1000 sf) that would yield gross rent of $7,000- $8,000 per year. Depending on the condition of the building and the treatment of tax, insurance and maintenance costs in the lease, the expenses can range from less than 10% to a high of maybe 40%. Let’s take the $8000 gross, say expenses run 25% and the Net Operating Income (NOI) is $6,000. (Coincidentally, with a 10% capitalization rate, that would yield a value of the $60T you mentioned, though you didn’t say how you arrived at that value.)

My strategy would be to use the option period to find a tenant and create value based on the income stream. With a good commercial tenant lease of three to five years, the property can be valued and financed based on its income and the quality of the tenant. While income properties are a bit more exposed to economic cycles than residential, the risk can be mitigated by using sound tenant leasing and screening practices.

Unless the seller is financing the purchase or you are paying cash, (yucchhh!), then you’ll need to know how much you can borrow. Most local banks will look for a minimum debt coverage ratio of about 1.3 on a property like this. That is to say that there is $1.30 of net income available to pay each dollar of proposed debt service. So divide the NOI by 1.30 (6000/1.3 = $4,615 available per year, or $384 per month for debt service. If the loan is at 10 % for fifteen years, then the payment factor per thousand is $10.75 per month, then $384/10.75= $37,720 is the maximum loan amount under those terms. Your cash flow will be about $115 per month. The upside is that most commercial leases have annual increases built in, so your NOI will rise in later years while a (fixed) loan payment will remain the same, raising your cash flow.

Obviously, if your deal has a higher average rent amount in the market, or you have a line on an extremely good tenant, then you can project an even better profit. At a $10 per sq ft. rental rate, the NOI would be $7500, the maximum loan $44,745 on the 1.3 DCR. That raises the possibility of a closing where you get paid to buy. Please note that this is all speculation since I know nothing of the actual situation. This is just me iffin’ ‘n andn’?

To get in the deal, if you’re buying for $47T, then there is $10T above the maximum 1st mortgage amount that has to be put into the deal in some fashion. That could be a cash down payment, a seller mortgage, or maybe its your tenant’s first and last month’s rent that you can then use as a cash down payment! It could be something traded to the Seller, such as a boat, or a car, or a vacant lot, or any other combination of value that you and the seller can agree on. Obviously, the cash flow is going to be slim at this set of conditions, but depending on how the deal can be structured you could have a nice long term investment. Without more information it is hard to develop any further thoughts.

Good luck!


Re: I got an option on a COMMERCIAL building. One more thing… - Posted by Eric C

Posted by Eric C on April 03, 2000 at 14:11:38:

Couldn’t resist using some dots… thought I’d get David Alexander’s attention…

Anyway, one more thing I’d like to mention is that during this period of corporate consolidation and downsizing, many companies are in the market to purchase (or re-purchase) competitors and franchises.

In this market, the RE often gets overlooked. And what gets overlooked, can often be very profitable.

For example, a pizza chain is buying back some franchises (a very common occurence)and has to honor the RE leases that go with the deal. Many times they will negotitate tough on the value of the business, but drop the ball when it comes to the RE. The reason: it comes out of a different pocketbook and is a completely different animal as far as corporate accounting is concerned.

I have been in the middle on some of these (in fact, I’ve got one going now) where I option both the business and the RE, sell the RE to the corporate parent and keep the lease (and the RE) for myself.

Works well.

Good luck,

Eric C