Help Evaluating Real Estate Deal


#1

Hello everyone,

My soon to be father-in-law is looking to buy a property. We’ve been talking about it for a few days. I wanted to get your opinions on it as well. Unfortunately I do not have all of the specifics (he doesn’t want to tell me dollar values).

He is looking at purchasing a property in upstate New York. It is in a relatively “small” college town. There is currently a franchised (backed by corporate) tenant in the property. If he decides to purchase the property, the tenant’s rent will be 4.5% of the purchase price. The corporate entity will guarantee the rent for 16 years. This corporation will not go out of business anytime soon.

He is concerned about the health of the town the property is in. It is a fairly small town with a strong state college presence. Average income is about $20,000 and average household income is closer to $40,000. The town has survived for so long because of the college. I consider the location to be extremely positive. It is very close to shopping (e.g. the local Walmart) and others. College students are also within driving distance. The building is a few years old and recently redone.

With the new NY student loan assistance, I do not consider the university a risk – it’s also a fairly popular university. From my perspective, 16 years of guaranteed rent means worst case scenario, he will make back 72% of his purchase price and still own the land, meaning the value of the property can drop by 72% and he would still break even. I believe the yearly rent for the property is about $55,000 per year, but I’m not entirely sure.

I’d appreciate any thoughts on this, thanks!


#2

If the rental income is ~$55,000 and that’s 4.5% of the purchase price, I’ll assume the purchase price is roughly $1.2M.

Is the lease NNN? Will he pay cash or is he getting a loan? Is he self managing or hiring someone to manage the property and tenant?

Having a solid tenant in a newly renovated building that it’s a prime spot is great, but may not be enough for this to be profitable.

Great businesses don’t need to go out of business to leave town. McDonalds, by all accounts, is a pretty healthy business (obviously not for human health), and they just pulled out of my neighborhood despite lots of new businesses, property values skyrocketing, and incomes going up. Actually, it was because of those things… the gentrification of the neighborhood meant less business to McDonalds, so they shut down.

I highly recommend checking out BiggerPockets.com and posting this question on their forums. They also have a lot of great articles on investing in commercial real estate.


#3

16 years of guaranteed rent is worth an extra 5%. Usually you only count 95% of rent to cover for the occasional loss of rent to replace tenants. If you are getting a guarantee that is 100% of rent coming in for the first 16 years. That is awesome.


#4

@NatPhorU

The rental income is about $55,000. Specifically, it is $55,000 NOI and as the property owner, he has “no landlord responsibilities.” He said that he got a very good deal on the property – he’s been negotiating back for forth for a few weeks. The price might be closer to $1 million but I’m not 100% sure because I won’t be getting all the details. I will say that he is an excellent negotiator.

It is a “True NNN ground lease” – so that seems good. I’m not sure if he will be financing the property or paying cash outright. He would be self managing the property. He has self-managed liquor stores, parking garages, and other businesses before (from the perspective of both running the businesses, and as a landlord). As per the property listing, the corporate entity will be taking care of the grounds. This particular franchise has been running for the past 50 years.

The tenant is very solid, corporate is rated BBB+ by S&P and Baa1 by Moody’s. We aren’t super concerned about this particular franchise going out of business because they’ve been there for 50+ years, and corporate guarantees the lease for 15 years. If they franchise goes out of business, corporate continues to pay rent until the original 16 years are up, or they find another tenant at a similar rate.

@OthalaFehu

The rent is guaranteed, which is why the rent is a little bit lower. 100% of the rent would be coming for the first 16 years OR corporate will find another tenant for similar rent. Not sure of the definition of “similar” rent though. Probably within some margin.


#5

David: That doesn’t sound like a great deal to me, but I would need to know a lot more details to be sure. My goal is a cap rate of at least 10%. I have more than 50 commercial tenants in two office parks and gross rent per year equals 10% of my investment. I manage the properties myself, so I don’t have to pay a manager, and we own the buildings and property free and clear, so there is no interest expense. However, there are still maintenance expenses, insurance expenses, property taxes, and other expenses to pay. I’ve been doing this for more than 30 years, and have a lot of experience. The guarantee may or may not be worth anything. I’ve had renters (including corporations) move out in the middle of the night, go bankrupt, go out of business because of global competition, cause damage to buildings, move to another state where they can’t be sued (or even located), and everything else you can imagine. The only time I feel confident about rent is if the tenant pays up front in advance for a year or more. Renters who can pay a substantial sum of money in advance are usually dependable and trustworthy. Real estate ownership can be fun and profitable, but it can also cause a lot of headaches. You have to be very flexible as well as demanding, and it helps to be a “people person” who can find win-win solutions to all of the strange and unforeseeable circumstances that may arise. You also need a strong lease agreement that can withstand attacks in court, protect your interests, and require the tenant to pay all legal and court expenses. Your future father-in-law would be well advised to do a lot of research about rental property management before he jumps into this. Best wishes.


#6

Hi @zendancer

Thank you for your insight. Unfortunately I can’t really get more details because he won’t tell me.

I’ll send you a PM with a little more information as that might help