Buying a commercial property - two clinics/pharmacies

[Sajimone]

My wife and I found two commercial properties that serves 4 business tenants.. each building renting out to clinics and pharmacies in two different cities.   NOI is 51-54k annually for each property.   These are NNN leases with annual 2-5% automatic increases in rent with long term tenants and leases that expire in 3-4 years each although all tenants appear to be staying for the long term.   Cap rate is about 9.6%.  The seller accepted our $1.1million offer and now we're in the process of hiring a real estate attorney to draft the contract and also looking to finance with 30% down.   The commercial bank that Im working with appears positive for underwriting this property.  I will also have my CPA review their accounts as well.

Down payment - $330k for $1,100,000

NOI for both - $106k annually

Cash on Cash return - 32%

Since this is our first commercial property purchase... we've done single family homes previously.. I would highly appreciate ANY feedback or advice as we move forward with the purchasing process?  Any advice on the commercial contract, contingencies we should put in there, any advice on the financing?  Other than the leases, PL statements, any other documents we should review as part of the due diligence?

[Zaphod]

Man, those cap rates are awesome. Hope it goes well for you.

[Dont_know_mind]

The commercial lease is crucial, so make sure it is tight.

Who is guaranteeing the leases ?

"long term tenants and leases that expire in 3-4 years each although all tenants appear to be staying for the long term..." Why do you think that ? If they definitely wanted to stay, would they not ask to renegotiate for a 5x5 lease ?

Are rental increases CPI plus ?

Who is selling to you ?

What is the potential for capital growth ? Is there any redevelopment potential ?

Can you buy it in your retirement account (with 60% leverage)?

[Kamban]

Sajimone wrote:

each building renting out to clinics and pharmacies in two different cities.

Click to expand...

Evaluate each business carefully. You have only 4 tenants. If one goes out and you can't replace them it quickly it will become a huge cash drain.

We bought a commercial building 2 decades ago with a large group of investors. Everything looked solid with a national chain grocery and a national large chain pharmacy as the main anchor tenants.

Guess what. Within a few years that large grocery chain was sold to a hedge fund who broke it up and reorganized and as a part of it the store was closed when the lease expired. They ripped out the AC and other units they put in for their freezers and now the unit is still awaiting a tenant. The Pharmacy Eckard got bought over by CVS who promptly closed it when the lease expired. It has taken years to re rent it out and now the monthly rent is much lower.

Things can go south due to large corporate mergers and take overs beyond your control.

[Sajimone]

Each lease is base rent plus equivalent sum of all sales tax.  Per the leases, annually the rents are increased proportional to the CPI or 3-5% whichever is greater (two clinics are 3% and two pharmacies are 5%).  No one sold it to me..?  I found it on loop net within the week it was listed.  The same bank that's underwriting these properties for me have provided financing previously to the sellers.  I prefer to leave my retirement accounts alone in index funds and prefer to use liquid cash which is a small part of my portfolio for these "high" risk investments.

“long term tenants and leases that expire in 3-4 years each although all tenants appear to be staying for the long term…” Why do you think that ? If they definitely wanted to stay, would they not ask to renegotiate for a 5×5 lease ?  ...    The tenants have been there for 7+ years...  I can look at their estoppel certificates to see how they're doing financially.. correct?  Nothing is guaranteed.. but if business is well for them and they verbally state long term plan to stay at the property... what else do I need to verify their long term plans to stay at the property?  How do I guarantee the leases?

What is the potential for capital growth ? Is there any redevelopment potential ?  ...  How do I go about evaluating this question?

appreciate the input!

[Kamban]

Sign at least 5 year leases with automatic renewal unless they give 6-12 month notices. Its is quite an effort to find suitable large tenants unless you line them up a few months in advance.

Are these pharmacies large national ones like CVS or Walgreens. Otherwise the future is always uncertain. Will the clinics merge and leave or get bought out by the hospital.

Other than the rent minus expenses, the main capital appreciation is the land and building. Buildings age and require maintenance and get outdated. So the land is your best bet.

Finally have the roof checked. Our large building had the roof replaced and 17 years later it needs another roof. Cost $90-110K to do it.

[Dont_know_mind]

I am not very experienced with retail leases. I mainly deal in industrial property and I don't like having too many tennants to deal with.

With the guarantees, this is important in the event of break of lease. The entity may get hollowed out and have no assets to pay you the remaining lease or if you take them to court if they leave 6 months mths after you buy with 2.5 years on the lease. Court may only award you part of the remaining lease. I would seek a personal guarantee for the remainder of the lease or at least a letter of credit.

It is great you are getting active in your investing. I have only bought in my particular city. But it may work out well for you if you get a good property manager.

With the lease, how will you know it is being checked on. Say there is a bad tennant, they don't pay insurances or taxes or outgoings. How long would it take to find this out. Say the building burns down - how will you recover it ? Are you paying the building insurance ?

If there is limited potential for capital gain I would look at the option of buying it in retirement account. Tax will be less than otherwise on the rental return.

Potential for capital appreciation is hard to figure out but to me would boil down to land value and redevelopment potential.  Old shopping buildings in high demand area with severe lack of parking for example or whatever features you think are likely to prompt local government and developers to seek to redevelop the area. I agree with Kamban that land tends to appreciate and buildings depreciate or require maintenance.

[Hatton]

My now ex-husband and I were offered the opportunity to invest in some Dollar General buildings.  These tend to be in rural areas and the buildings are cheap.  The company runs the business etc.  My concern if for any reason they did not renew the lease you are stuck with a cinder block building in the middle of no where and no other tenant prospects.  Did not invest.

[Sajimone]

I appreciate everyone’s responses and input! It’s been a ride for sure. We almost lost the properties as we didn’t turn the contract in on time and the seller gave it to the next buyer. We persisted with getting our contract in plus our bank approval. We were placed as a backup contract. 6 weeks later.. the other buyer had requested an extension of his due diligence period.. which lead the seller to give the properties right back to us. We’ve completed the inspection with a minor HVAC roofing the issue. The seller quickly agreed to make arrangements to have all items on the inspection list repaired. Again nothing major. The appraisal came back at just above our purchasing price. We will close within 1-2 weeks with Seacoast.

Here are my numbers.. 20 year term. 20% down on 1.1million purchase price for two buildings with 4 tenants. 4.9% interest rate. We paid about $4500 for the appraisal. $800 for the inspection for two buildings. The property is NNN. Monthly debt service payment of $5700. The income per month roughly $8700. Cap rate 9.6%. Cash on cash return just with the cash flow is 16%. Cash on cash return with current cash flow plus principal paid year 1 is 28% and it only gets better assuming the tenants stay.

Although the tenants which includes two pharmacies and two clinics have been and appear to be there long term.. we’ve met them personally.. I’ll plan to hold 6 months emergency funds for this property before paying extra on the loan principal. I don’t need the cash flow.. but I’m willing to use it for any potential value-add opportunities to the property. For example.. we’re checking the city zoning to see if we can build further on the property and add new tenants? Hope this helps!