If you are new to commercial real estate as an investment vehicle, then perhaps you should consider multifamily rather than single family residential.
People look for single family properties they can rent because they have the expertise from a lifeime of buying single familiy properties for themselves. The entry to the investment is cheaper, and does not require a lot of knowledge or number crunching. The question is, "Will it produce rent, and will I net enough to cover the mortgage and make a profit?" If it has never been rented before, then it's unlikely that you will know the answers, unless there are other owners of similar properties who are doing the same thing. But even so, the numbers and vacancy rates you hear about, may not be the real story.
Multi-family property investments are simple, especially if you use a broker who can crunch the numbers and explain them to you. They require a similar set of knowledge and skills as single family and there are so many different types, to choose from, one will certainly fit your investment style and comfort level.
Apartment buildings are one place to start. Remember for either investment of single or multi-family you will need the ability and willingness to hold for multiple years. Single-family properties require more management and maintenance, because each single family property issue is infront of the individual tenant. When a tenant moves out, you will have no income until a new tenant moves in. Maintenance is necessary for each property you own. Multi-family properties are easier in comparison to manage and maintain because of the consolidated maintenance and the rent security of multiple tenants for each property.
The property knowledge required for Multi-family is similar to single family, as it is still living quarters, but it will have common areas and amenities that can be shared by all tenants. With a Multi-family building, with a good rental history, then it is likely to continue based on that history. If something changes in the market, it's generally a percentage change over a period, and rarely 100%.
With multi-family properties, you will pay more to get started, but the idea is to find a property that will pay your debt service and then let the tenants pay your expenses. If you buy a solid property, well constructed, in a good location, then chances are good it will stay rented and not show wear and tear before you start making a profit. There are many sizes and types to fit practically any budget. Concrete, block or brick construction will last longer in most parts of the country over wood. The best properties can sometimes be the ones with a motivated seller. The worst will be the ones where the seller knows something that will effect the future revenue stream, that you do not know. We solve this with some due-diligence. Part of your due diligence will require you or your broker to drive the area to see if there is anything new which might effect your prospect property.
Consider multi-family properties over single family residential to reduce your vacancy risk, provide a greater return and bigger future upside.
Sunday, October 24, 2010
Tuesday, October 12, 2010
Barriers to Entry
When evaluating a business investment, one of the many factors for making a decision should be whether or not your future business is going to be unique. Can it be started by anyone, or is there something that keeps others from opening up the same type of business across the street, or even next door.
Lots of people call me to purchase a service business. One of these service businesses that attract attention are pool services. In Florida, if you own or rent a home with a pool, the pool will need regular service, otherwise, it will turn green. People hire pool service contractors to prevent this from happening. Overtime they learn what it takes to maintain the pool, and after a while start to service their own. Pretty soon they are offering the service to their neighbors and relatives. The next thing you know, they want to buy a neighborhood route from a pool service company.
The business itself is relatively easy, but it's time consuming and not very profitable if all you do is service pools. A license for servicing is not hard to get, but, as you will find, the real money is in parts and repair, and therein lies the 'rub.' In Collier and Lee Counties, in Florida, to get a license, it requires two years experience of pool service and repair, which must be proven or vouched for by other licensed persons. After completing the experience requirement, you must pass a difficult test. If you want to repair a pool pump or pool heating system, you need this license. This is a sample of 'barriers to entry.' If you are willing to scale the barriers, then you will have less competition.
If you are thinking of opening a business, then something unique and difficult will make it less attractive to competitors. When entry barriers are high more people will be reluctant to enter that type of business.
If you are successful, eventually others will want to feed off of your success by opening something near you. Why do you think there's a Walgreens and CVS Pharmacy on opposite corners of major intersections. The sad truth is, profitable markets that are successful will attract new competition. More competition will indeed increase traffic, but most likely decrease profitability. If you pick a shopping center where you can write some sort of exclusivity for your particular type of business, then you certainly should. That is another example of a 'barrier to entry.'
Business is hard enough without having competitors nipping at your customer base. If there are barriers to entry, you can hold them off long enough to recapture your investment and make a good profit. Good luck. Call me if I can help you.
Lots of people call me to purchase a service business. One of these service businesses that attract attention are pool services. In Florida, if you own or rent a home with a pool, the pool will need regular service, otherwise, it will turn green. People hire pool service contractors to prevent this from happening. Overtime they learn what it takes to maintain the pool, and after a while start to service their own. Pretty soon they are offering the service to their neighbors and relatives. The next thing you know, they want to buy a neighborhood route from a pool service company.
The business itself is relatively easy, but it's time consuming and not very profitable if all you do is service pools. A license for servicing is not hard to get, but, as you will find, the real money is in parts and repair, and therein lies the 'rub.' In Collier and Lee Counties, in Florida, to get a license, it requires two years experience of pool service and repair, which must be proven or vouched for by other licensed persons. After completing the experience requirement, you must pass a difficult test. If you want to repair a pool pump or pool heating system, you need this license. This is a sample of 'barriers to entry.' If you are willing to scale the barriers, then you will have less competition.
If you are thinking of opening a business, then something unique and difficult will make it less attractive to competitors. When entry barriers are high more people will be reluctant to enter that type of business.
If you are successful, eventually others will want to feed off of your success by opening something near you. Why do you think there's a Walgreens and CVS Pharmacy on opposite corners of major intersections. The sad truth is, profitable markets that are successful will attract new competition. More competition will indeed increase traffic, but most likely decrease profitability. If you pick a shopping center where you can write some sort of exclusivity for your particular type of business, then you certainly should. That is another example of a 'barrier to entry.'
Business is hard enough without having competitors nipping at your customer base. If there are barriers to entry, you can hold them off long enough to recapture your investment and make a good profit. Good luck. Call me if I can help you.
Friday, October 1, 2010
What is it worth?
We recently invited a respected appraisal company to speak to our commercial brokers. We are in one of those periods where the old rules of value do not apply. Lately an appraisal is only viewed as representative of the correct value by one party to any transaction. If the appraisal is high, then the seller will quote it as gospel. If it's low, then the buyer becomes a convert. But who really knows right now.
It use to be, back in the 'good ole days' that as commercial agents we could use three methods to value a property, and depending on your belief in the strength of the under-lying numbers, one would lead you to the correct value. For this discussion we will not discuss 'Highest and Best Use' of the property. We will assume we need to value for purchase or sale and its use will not change.
The appraisal company's position was, "when the majority of the comparables are 'shorts' and foreclosures, those prices become the comparable." He specifically said that the three methods of valuing commercial real estate are not valid in this market.
Here's a recap of the three methods and my thoughts on each.
Cost Approach - considers the current cost to reproduce a property minus 'wear and tear.' This assumes that a savvy investor would not pay for an old building if they could build new for the same or less. This was sound logic, when we had builders who had a normal work load and charged a fair price. With building work scarce, some are asking less than a fair rate. Maybe they want to use up materials or just have some cash flow, that might lead to more projects. This method is not consistent right now.
Income Approach - considers that a close relationship exists between the income a property produces and its value. This was my favorite, and seemed to me to be best when used by investors who were looking for a return. The problem now is that all tenants are asking for reduced rent. Most landlords have figured out that it is better to have some income, rather than none. So if and when we recover, the rents may or may not return. Do you rate value on current income, or lease contracts. Tricky at best, and hard to place the right value at this time.
Sales Comparison Approach - considers value to be a reflection of what other buyers are paying for similar properties. The problem with this is that most properties in commercial are different and the motivation of each buyer and seller is also different. Most buyers are demanding a bargain. Sellers want to avoid bankruptcy, others want some cash so they may hold on to other properties. Not many are selling now to get a good price. So, this method, which is the one the appraisers must use, is unreliable.
If you consider that our values might have been inflated by the idea you could buy anything, for any price, and still make money, then perhaps those values were wrong before we got into this mess. There was a greed and haste that led us down this path. Is this where we should be, or is it just an adjustment period correcting what was wrong before? Either way. it will work itself out, eventually. Business purpose leads to commercial sales, and when the bargains are gone, and the economy improves, then optimism in a business venture will draw investors and business users back to the market to chase income opportunities.
It use to be, back in the 'good ole days' that as commercial agents we could use three methods to value a property, and depending on your belief in the strength of the under-lying numbers, one would lead you to the correct value. For this discussion we will not discuss 'Highest and Best Use' of the property. We will assume we need to value for purchase or sale and its use will not change.
The appraisal company's position was, "when the majority of the comparables are 'shorts' and foreclosures, those prices become the comparable." He specifically said that the three methods of valuing commercial real estate are not valid in this market.
Here's a recap of the three methods and my thoughts on each.
Cost Approach - considers the current cost to reproduce a property minus 'wear and tear.' This assumes that a savvy investor would not pay for an old building if they could build new for the same or less. This was sound logic, when we had builders who had a normal work load and charged a fair price. With building work scarce, some are asking less than a fair rate. Maybe they want to use up materials or just have some cash flow, that might lead to more projects. This method is not consistent right now.
Income Approach - considers that a close relationship exists between the income a property produces and its value. This was my favorite, and seemed to me to be best when used by investors who were looking for a return. The problem now is that all tenants are asking for reduced rent. Most landlords have figured out that it is better to have some income, rather than none. So if and when we recover, the rents may or may not return. Do you rate value on current income, or lease contracts. Tricky at best, and hard to place the right value at this time.
Sales Comparison Approach - considers value to be a reflection of what other buyers are paying for similar properties. The problem with this is that most properties in commercial are different and the motivation of each buyer and seller is also different. Most buyers are demanding a bargain. Sellers want to avoid bankruptcy, others want some cash so they may hold on to other properties. Not many are selling now to get a good price. So, this method, which is the one the appraisers must use, is unreliable.
If you consider that our values might have been inflated by the idea you could buy anything, for any price, and still make money, then perhaps those values were wrong before we got into this mess. There was a greed and haste that led us down this path. Is this where we should be, or is it just an adjustment period correcting what was wrong before? Either way. it will work itself out, eventually. Business purpose leads to commercial sales, and when the bargains are gone, and the economy improves, then optimism in a business venture will draw investors and business users back to the market to chase income opportunities.
Monday, September 13, 2010
Other People's Money
We got where we are in this real estate mess because everyone was trying to make money in Real Estate. That is not possible. Someone has to lose at some point in the investment life of a property. But for some reason, not only did the investors believe they could, the banks believed the investors could too. The Stock market doesn't work that way, why should the real estate market.
While all investments share the same elements, some issues are only found in Real Estate investments. One is the ability to buy it with OPM. Other People's money.
All investments have risk, and liquidity issues. Some investments require you to actually manage them to get your return. Since there is a basis in the investment and an income stream, hopefully, there will be tax considerations. But, other than perhaps a margin account, you will have to put up all the cash for all other investments except real estate.
Using OPM is called leverage. If you can make more income than the cost of the debt service, then it's called positive leverage and that is a good thing.
Let's crunch some numbers to show the effect of using OPM, rather than your own.
Source of Funds Bank Bank Account
Investment $2,000,000. $2,000,000.
Out of Pocket 200,000. $2,000,000.
Cash Flow Year 1
Income $175,000 $175,000
Interest 77,126 0
Cost Recovery 9,828 9,828
RE Taxable Income 88,046 165,172
Tax Savings $24,653 $46,248
After Tax Investment Return 28.36% 17.61%
You can calculate this with a financial calculator or you can let me use a spreadsheet and run various scenarios for you. As you can see when you have less money at risk, and the investment returns more in income than the cost of the money, then in the term of the investment you will get a better return by using OPM. It has a lot to do with the spread between the Interest Rate and the Cap Rate on the investment. It also has to do with the tax advantage of deducting the interest against the income before calculating the tax. In this case, with the sample numbers shown the return is 11% greater with financing.
Investments can be risky, not everyone can make money. Don't make it worse and risk your own money if you don't have to.
While all investments share the same elements, some issues are only found in Real Estate investments. One is the ability to buy it with OPM. Other People's money.
All investments have risk, and liquidity issues. Some investments require you to actually manage them to get your return. Since there is a basis in the investment and an income stream, hopefully, there will be tax considerations. But, other than perhaps a margin account, you will have to put up all the cash for all other investments except real estate.
Using OPM is called leverage. If you can make more income than the cost of the debt service, then it's called positive leverage and that is a good thing.
Let's crunch some numbers to show the effect of using OPM, rather than your own.
Source of Funds Bank Bank Account
Investment $2,000,000. $2,000,000.
Out of Pocket 200,000. $2,000,000.
Cash Flow Year 1
Income $175,000 $175,000
Interest 77,126 0
Cost Recovery 9,828 9,828
RE Taxable Income 88,046 165,172
Tax Savings $24,653 $46,248
After Tax Investment Return 28.36% 17.61%
You can calculate this with a financial calculator or you can let me use a spreadsheet and run various scenarios for you. As you can see when you have less money at risk, and the investment returns more in income than the cost of the money, then in the term of the investment you will get a better return by using OPM. It has a lot to do with the spread between the Interest Rate and the Cap Rate on the investment. It also has to do with the tax advantage of deducting the interest against the income before calculating the tax. In this case, with the sample numbers shown the return is 11% greater with financing.
Investments can be risky, not everyone can make money. Don't make it worse and risk your own money if you don't have to.
Sunday, September 5, 2010
Is it a good business to buy?
I am a business broker, besides being a Commercial Real estate Agent. I make part of my living helping others buy and sell businesses. My role is transaction broker. I provide a limited form of representation to a buyer, a seller, or both, but do not represent either.
When people ask me if I think it is a good business, I have to tell them, "I am a salesman, I get paid if you buy, or if the owner sells. " do you really want to rely on my opinion?"
I try to use the businesses I put people in, so I would prefer that they are happy with their purchase. The trouble is, I have sold lots of them, and many were restaurants. If I frequented all of them, I might be much larger than I already am. But the key is, I try to help them through the transaction so that they have all the facts, so, if they buy, they are happy, even if I do not visit them regularly.
I do not know what makes a business successful. I don't think everyone who buys a successful business, will be successful. Nor will those who buy one that has failed will fail again. It is a formula which I do not have. I think you need the right mix of people, products, atmosphere, supply, demand, elbow grease and luck. Your business will need management, and decisions that will affect your day to day success. Some businesses succeed through sheer hard work. Others need something else. I suggest that you buy something, in which, you have experience, or at least enough knowledge to understand how it makes money and how to continue doing so.
Buy a business that needs your skills and is something that you will enjoy. Buy something for which you have passion and truly believe that you can make better.
Success will depend on you and the business. Lots of people buy a business to create a job for themselves. That is okay as long as you are qualified to satisfy the customers of that new business. Those customers are your new employer. If you make them happy, then you have a better chance at success.
Am I trying to scare you? No. All business involves risk. I just want you to be so sure that you can make it work, that it is worth that risk to you.
When people ask me if I think it is a good business, I have to tell them, "I am a salesman, I get paid if you buy, or if the owner sells. " do you really want to rely on my opinion?"
I try to use the businesses I put people in, so I would prefer that they are happy with their purchase. The trouble is, I have sold lots of them, and many were restaurants. If I frequented all of them, I might be much larger than I already am. But the key is, I try to help them through the transaction so that they have all the facts, so, if they buy, they are happy, even if I do not visit them regularly.
I do not know what makes a business successful. I don't think everyone who buys a successful business, will be successful. Nor will those who buy one that has failed will fail again. It is a formula which I do not have. I think you need the right mix of people, products, atmosphere, supply, demand, elbow grease and luck. Your business will need management, and decisions that will affect your day to day success. Some businesses succeed through sheer hard work. Others need something else. I suggest that you buy something, in which, you have experience, or at least enough knowledge to understand how it makes money and how to continue doing so.
Buy a business that needs your skills and is something that you will enjoy. Buy something for which you have passion and truly believe that you can make better.
Success will depend on you and the business. Lots of people buy a business to create a job for themselves. That is okay as long as you are qualified to satisfy the customers of that new business. Those customers are your new employer. If you make them happy, then you have a better chance at success.
Am I trying to scare you? No. All business involves risk. I just want you to be so sure that you can make it work, that it is worth that risk to you.
Sunday, August 29, 2010
Creative Building Finance
If you are like a lot of business owners, your cash flow has been down the last three years. And now of course, the price of buildings have dropped dramatically. Interest rates are also way down, but you do not have the down payment to allow you to buy today. I am working with a company now who is facing these same issues. If they purchased, the monthly debt service on the building purchase would be less than their monthly lease payment.
I went to the building owner and offered a creative plan to get everyone what they wanted. I asked the owner to give the buyer the right to lease the building now, under some reduced rate and allow them an option to buy within twelve months.
This was a new building, and the buyer needed some customization improvements to make it fit their need. They had someone to do these improvements for them so it would not involve the landlord footing that bill.
I wrote a letter of intent to the owner for a three year lease, and asked for two months free rent to allow the buyer to move and improve the space as needed. I then asked for three months rent at half the normal rents with regular rents thereafter. I included an option to buy the building in the first twelve months at a rate comparable to other spaces selling in the area, with a little premium for the seller. I included a clause that after twelve months the purchase price would increase to the greater of three percent or the average price of sold listings for comparable properties in the area.
This is what I call 'Creative Finance.' This particular buyer had expectations of some growth and needed additional space. They were expecting a big contract in the next few months which would allow them to buy. This plan allowed them to move now, with significant reduction in out of pocket expense, tie up the building they wanted, so they didn't lose it and then give them a lease price comparable to match their budget, but in new space that they could own when their cash flow improved.
The building owner was getting the cost of carrying a vacant building paid for, a market rate lease if it didn't sell , and the liklihood to sell at a good price when buyer got their big contract. It was 'win-win' for both parties.
Sometimes you need a broker on your side to find a solution. We don't make any money unless some property changes hands, so in this market, we have to be creative. Call me to discuss your situation. Let me be find a creative solution for you.
I went to the building owner and offered a creative plan to get everyone what they wanted. I asked the owner to give the buyer the right to lease the building now, under some reduced rate and allow them an option to buy within twelve months.
This was a new building, and the buyer needed some customization improvements to make it fit their need. They had someone to do these improvements for them so it would not involve the landlord footing that bill.
I wrote a letter of intent to the owner for a three year lease, and asked for two months free rent to allow the buyer to move and improve the space as needed. I then asked for three months rent at half the normal rents with regular rents thereafter. I included an option to buy the building in the first twelve months at a rate comparable to other spaces selling in the area, with a little premium for the seller. I included a clause that after twelve months the purchase price would increase to the greater of three percent or the average price of sold listings for comparable properties in the area.
This is what I call 'Creative Finance.' This particular buyer had expectations of some growth and needed additional space. They were expecting a big contract in the next few months which would allow them to buy. This plan allowed them to move now, with significant reduction in out of pocket expense, tie up the building they wanted, so they didn't lose it and then give them a lease price comparable to match their budget, but in new space that they could own when their cash flow improved.
The building owner was getting the cost of carrying a vacant building paid for, a market rate lease if it didn't sell , and the liklihood to sell at a good price when buyer got their big contract. It was 'win-win' for both parties.
Sometimes you need a broker on your side to find a solution. We don't make any money unless some property changes hands, so in this market, we have to be creative. Call me to discuss your situation. Let me be find a creative solution for you.
Thursday, August 19, 2010
4.25% Interest Rate on Commercial Loans
I mentioned a perfect storm in a previous blog, which was lower interest rates and lower prices for commercial property. But now the rates are coming down even more, and I have to bring it up again, with more detail, so you don't miss it.
Some Commercial lenders have lending rates that mirror the Bond Market. Interest rates are tumbling in the Bond Market, so the these Commercial loan rates by lenders are spiraling down as well. This is one of those times where business owners who are dissatisfied with their facilities need to look closely at what they are spending on rent.
Let's crunch some numbers: Renting 8,000 square feet at $10 per square foot is $80,000 annually, or $6,666 monthly. If the space is for sale for $100 per square foot, as many are right now, that's $800,000 purchase price.
In order to qualify for rates like these, you need at least 20% down and occupy more than 50% of the space.
$800,000 X 20% Down payment = $160,000
Purchase price $800,000 - $160,000 = $640,000
Annual debt service on $640,000 at 4.25% with a 20 year amortization = $47,557 or $3,964 monthly.
Even if you are paying less than $10 per square foot to lease, it is still phenomenal.
Lease rate samples:
$8 X 8,000 sq ft = $64,000 $5,334 Monthly
$7 X 8,000 sq ft = $56,000 $4,667 Monthly
$6 X 8,000 sq ft = $48,000 $4,000 Monthly
$5 X 8,000 sq ft = $40,000 $3,333 Monthly
You cannot make your cash work for you better than building equity in your own property. If you can pay less, then it is outside of reality.
Here are some amortization numbers on some other sample amounts, You should be able to estimate your actual numbers from these
Loan Amortization samples:
Loan $ 500,000 at 4.25% amortized on a 20 year scale with five & ten year balloons $ 3,096
Loan $ 250,000 at 4.25% amortized on a 20 year scale with five & ten year balloons $ 1,549
Loan $1,000,000 at 4.25% amortized on a 20 year scale with five & ten year balloons $ 6,192
Loan $2,000,000 at 4.25% amortized on a 20 year scale with five & ten year balloons $12,384
Loan $3,000,000 at 4.25% amortized on a 20 year scale with five & ten year balloons $18,578
With these kinds of numbers, you might want to invest in your company instead of the stock market. Call me, let me help you find better space and a better bottom line for you and your business.
Some Commercial lenders have lending rates that mirror the Bond Market. Interest rates are tumbling in the Bond Market, so the these Commercial loan rates by lenders are spiraling down as well. This is one of those times where business owners who are dissatisfied with their facilities need to look closely at what they are spending on rent.
Let's crunch some numbers: Renting 8,000 square feet at $10 per square foot is $80,000 annually, or $6,666 monthly. If the space is for sale for $100 per square foot, as many are right now, that's $800,000 purchase price.
In order to qualify for rates like these, you need at least 20% down and occupy more than 50% of the space.
$800,000 X 20% Down payment = $160,000
Purchase price $800,000 - $160,000 = $640,000
Annual debt service on $640,000 at 4.25% with a 20 year amortization = $47,557 or $3,964 monthly.
Even if you are paying less than $10 per square foot to lease, it is still phenomenal.
Lease rate samples:
$8 X 8,000 sq ft = $64,000 $5,334 Monthly
$7 X 8,000 sq ft = $56,000 $4,667 Monthly
$6 X 8,000 sq ft = $48,000 $4,000 Monthly
$5 X 8,000 sq ft = $40,000 $3,333 Monthly
You cannot make your cash work for you better than building equity in your own property. If you can pay less, then it is outside of reality.
Here are some amortization numbers on some other sample amounts, You should be able to estimate your actual numbers from these
Loan Amortization samples:
Loan $ 500,000 at 4.25% amortized on a 20 year scale with five & ten year balloons $ 3,096
Loan $ 250,000 at 4.25% amortized on a 20 year scale with five & ten year balloons $ 1,549
Loan $1,000,000 at 4.25% amortized on a 20 year scale with five & ten year balloons $ 6,192
Loan $2,000,000 at 4.25% amortized on a 20 year scale with five & ten year balloons $12,384
Loan $3,000,000 at 4.25% amortized on a 20 year scale with five & ten year balloons $18,578
With these kinds of numbers, you might want to invest in your company instead of the stock market. Call me, let me help you find better space and a better bottom line for you and your business.
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