Posted by jim on August 30, 2010 at 24:02:17:
thanks Bill. A questions I do have though: how did you find your deals? the only place I know of is loopnet. that’s where I have been looking for C.R.E. opportunities. are there other ways of looking for good commercial deals?
thanks
what’s the motivation to buy C.R.E? - Posted by jim
Posted by jim on August 17, 2010 at 14:19:46:
I am new to commercial real estate. I do own a bunch of residential houses. they are generating very good positive cash flow ( I have been hard working at placing good tenants in there).
then I started looking at strip malls and other commercial stuff in my area, the ones with existing tenants, generally have cap rate of no more than 7.5%.
so my question is, if I invest in those, with the commerical RE mortgage interest rate about close to 7%, what kind of return am I expectings? there seem to be very little income left, if any. I am getting higher cap rate on my residential houses (>15%).
also, the rent for commercial tenants seem to be fixed ( not too sure or familiar about this though). assume markets turn around in 7 years. even if the market rent go up at that time, how do I benefit from it if the lease for the tenant is based on the rent from today?
Re: what’s the motivation to buy C.R.E? - Posted by Frank Chin
Posted by Frank Chin on August 18, 2010 at 12:19:34:
It’s different strokes for different folks. Based on your returns, you are a cash flow investor.
People buy commercial real estate for various reasons, and for many, good cash flow is not one them.
My dad fell into commercial real estate quite by accident. He owned a business, and back in the early 1960’s, he noticed some businesses were forced to close, and many others struggling because of rent increases. The building where his business was located was first sold to an investor, and a year or two later, he offered this investor 10% more that what the investor paid for it, and took over the building.
As I learned later, many smaller properties are bought by users, businesses that use the space they own, to control costs, and making 7.5% return on the property or more is not one of them. For people like you, you are competing against the user-investors.
As years went by, commercial rents escalated, and went up much faster than residential rents, he was quite pleased, as other competitors struggled, raised prices, he was able to profit nicely, due to the fact that his “fixed rate mortgage of 5%” remained constant, and his business did tremendously well as he did not have to worry about rent increases.
He bought the building in 1963, and store rents at the time went for $250.00. By 1980, store rents was in the $1,000 to $1,500 range, and he had another store besides his own that he rents out. He was getting tired from the business, so I talked him into retiring, just collecting the rent. In 1980, the building was paid off, with two stores, he makes $3,000/month rent from the stores, an apartment upstairs went for $800, and more rent from 4 garages.
Another advantage of commercial real estate became apparent. With stores, the store owner do all the maintenance, pay his real estate taxes, pays the heat. With a good businesses, you don’t have tenants moving out evey two years either. In the winter time, he didn’t have to shovel the snow as I have to for my 2 and 3 family houses.
To summarize, commercial real estate is easier to manage.
In this period, commercial rents rose a lot faster than residential rents, more than twice as fast, and consequently, the value of commercial real estate went up twice as much. In 1963, he paid $25K for the property. He had an offer of $250K for it in 1980, a 10 fold increase.
Residential properties did not go up ten fold between 1963 and 1980 in the area, though it went up 4 to 5 fold, not bad either.
Why did commercial rents go up so fast??
A friend of mine who pumped gas for his uncle while paying his way through college told me why. In one year while he was working there, all the gas stations registered a 25% increase in the volume of gas sold. It turned the econmic activity of the area was exploding.
In five years, everyone’s volume doubled.
I was talking to him, and it occurred to me the population in my dad’s area increased tremendously as well, with new construction, businesses going in. In fact, the amount of commercial space in the built up area remained static, and my dad in fact had businesses chased out of more expensive areas because of high rents, coming by beggging him to rent his store, if he can only get the current tenant to leave.
Now, commercial real estate in built up areas are high, so the returns are low. The trick here to is to see where the population growth is, move ahead of the curve, and be where my dad was in 1963. To do this, you would have to study the census data, macro economic trends.
This is a completely different animal than cash flowing from residential rentals.
Re: what’s the motivation to buy C.R.E? - Posted by BigV
Posted by BigV on August 18, 2010 at 07:53:50:
If you don’t mind me asking, what kind of residential properties do you own? Single family or multi-units?
I’ve been considering commercial residential properties and have been reading Steve Berges’ books. Steve advocates bying properties in need of some updating, update the properties, increase rents and sell for a profit.
Is this how you are operating also?
Re: what’s the motivation to buy C.R.E? - Posted by Bill Jacobsen
Posted by Bill Jacobsen on August 17, 2010 at 16:56:58:
If you can get property at a 15% cap rate you would have no motivation to invest in commercial property.
In my area we can buy single family properties at about 12 to 13 times yearly rental rates. If you add 1.5% of home value for property taxes and insurance you are already at 6.5% without an allowance for vacancies or maintenance.
By the way I did just buy my first Office building for less than 5 times yearly rents.
Good Luck
Bill
Re: what’s the motivation to buy C.R.E? - Posted by jim
Posted by jim on August 18, 2010 at 18:57:45:
very good to read your father’s story. one question I do have though, for commercial leases, can owners raise the rent after a few years? how is future rent determined, is it fixed in the lease or it’s subject to renegotiation 5 or 10 years from now?
this is important. because if I sign a lease which locks the rent with the tenant for next 10 years, and if the market rent go up 50% 5 years from now, I am essentially losing significant rent income which I could have gotten. meanwhile, if I attempt to sell it 5 tears from now, the new buyer wouldn’t have wanted to pay its fair price, because he would be getting below market rent at that time.
anyhow, I am new to commercial R.E. any info is highly appreciated.
Re: what’s the motivation to buy C.R.E? - Posted by jim
Posted by jim on August 18, 2010 at 18:48:31:
I mainly buy single families. I fix and rent them out, hoping they will appreciate in 5 years or longer. some people do fix and sell. but I found the profit is relatively thin, so I hold and see if they appreciate enough.
Re: what’s the motivation to buy C.R.E? - Posted by jim
Posted by jim on August 18, 2010 at 18:51:34:
hi, Bill. which area are you in? I am definitely interested in these type of deals like yours. I am in S.F. bay area. the residential houses in east oakland were good deals last year. they went up quite a bit this year. I am interested in bigger cap rate commercial deals. thanks.
Re: what’s the motivation to buy C.R.E? - Posted by Woody
Posted by Woody on August 18, 2010 at 20:10:22:
Jim-
Commercial rents are charged per square foot and the term of the lease is typically a number of years. Recently I was looking at a 1,500 square foot retail space in a strip mall. I ran comparable rents for similar commercial spaces and came up with $20. per square foot. Knowing that commercial real estate is in tough times trying to find tenants I negotiated $14. per sq.ft. with a five year lease term and would also have the option to renew for an additional 5 years. In-addition, I had 4 months of no rent payments at the start of the lease to allow one month to upfit the property, and I would have 3 months free rent to start up the business. The owner came back with “yearly” rent increase of about $.50 to $1.00 per sq.ft. So at the end of 5 years it was back at about $18.50 sq.ft.
So basically the rent amount is not locked in and can increase during the lease term.
As it turned out I backed out of moving forward with this lease for other business reasons. If I did stay in, and knowing the crummy commercial market we are in, I would have continued to negotiate a low fixed rent amount.
Re: what’s the motivation to buy C.R.E? - Posted by Frank Chin
Posted by Frank Chin on August 18, 2010 at 19:34:51:
Jim:
I owned a business for a number of years, and unfortunately I was also a commercial tenant. There’s a number of ways landlords handle rental income and rent increases.
First, most commerical leases here calls for tenants to pay property taxes, utilities including HVAC, and often insurance. So these costs are passed along to the tenants right away as they go up.
In the 1960, 70’s my dad signed leases with tenants locking the rent in for a number of years, mostly 3 years. No longer. The lease I took over from a prior owner of the business with the landlord started at $3,600/year in the year 2002, increases every year, and reached $4,800/year around 2007, and this is just the base rent. Taxes, and it’s increases are on top of it.
So, you can see rents are NOT locked in for a number of years. I sold the business because comparable properites rent at over $10,000/month, one guy was paying $13,000/month, so comparatively I had a bargain. I increased my sales and gross profit tremendously, but unfortunately I concluded that in the long run, all of it is going for rent.
I came to the sad conclusion my dad was right about owning the premises in which the the business operates from.
Leases are structured differently all over. I have a tenant who owns a dry cleaning business whose landlord demanded a $5,000 payment so he can have a lease. It’s called key money here.
The owner who sold me the business was socked by the landlord for an assignment fee of $50,000 before he can sell me the business with a lease that was assigned. This I understand was due to him giving the landlord a hard time and disrespectful.
When I sold my business though, the landlord did not ask me for any assignment fees, but asked that I install a new roof costing me $6,000.00.
Some businesses like restaurants pay a base rent plus a percent of their revenue.
I would suggest you take a more in depth look into commercial real estate practices before you go ahead.
Re: what’s the motivation to buy C.R.E? - Posted by Bill Jacobsen
Posted by Bill Jacobsen on August 18, 2010 at 22:12:20:
I live in Salem, Oregon, about 50 miles south of Portland. The little office complex that I mentioned was in Albany, another 20 miles south of me.
Bill
Re: what’s the motivation to buy C.R.E? - Posted by chi ming
Posted by chi ming on August 18, 2010 at 20:02:57:
Reminds me of the lawsuit by the managers of Mervyns, a
clothing chain that used to operate in CA. Investors
bought the retail chain then split off the real estate
and sold it to investors (Mervyns would buy their
retail space to control costs). The investors moved
the rent up to market, which in many cases was over 10x
what they had been paying for the space. They went
under as a result. The managers are suing the
investors who essentially put them out of business by
stripping out and selling off the assets owned by the
company.