Commercial Real Estate – The Profit is in the Details!Posted on May 6, 2013 by
Commercial Real Estate
Buying Commercial real estate with your self-directed IRA is not much different than buying a residential property, except commercial real estate purchases require a whole lot more due diligence.
Commercial Real Estate – Get the Real Numbers!
The offering says gross potential, (a.k.a. pro forma). This is one of the things you’ll run into all the time. The broker says it’s got a great pro forma. Here’s what it can generate. You want to find out what it did generate, not what it’s going to generate. You want to buy what it’s doing today.
With REOs, foreclosures and distressed sales, you’re going to have to evaluate things on a case-by-case basis and get the real numbers.
Commercial Real Estate – The Truth is in the Documents!
This section outlines the many important documents you need. Having said that, remember you can make the offer in advance of receiving all of the below as long as you make the offer contingent on the receipt of the documents you need. A note about contingencies: make sure you are very specific including amounts you expect to see on the documents, ability to get insurance at the current cost, verification from the county of zoning specific to what you intend to do with the property, etcetera.
A lease is the most important document. Read every lease line by line and make notes, or get somebody that knows how to read leases line by line. Are there any special arrangements? The landlord says they’re paying $1,000 a month, but it turns out that I’m obligated every year to repaint the place, re-carpet the place, and so forth.
Rent rolls help identify the turnover and collection issues. They contain the list of tenant names and contact numbers, and the rent amounts. Make sure the lease information matches the rent roll.
With existing loans, you want to review the loan documents and find out if they can be assumed? Is there a prepayment penalty? Is there an extension available? What is currently owed and what are the terms?
The other thing you want to find out is will they allow subordinate financing? Many commercial loans don’t allow subordinate financing. If you’re looking at creative financing or all-inclusive deeds of trust and if you can’t put a second on there, that creates a problem. Make sure the rent files are complete. You should have an application, a credit report, a criminal background, a signed current lease and a variety of other things.
Check the utility bills for usage. You may have a tenant in there that’s using too much water, too much electric or too much gas if they’re centrally metered on a large commercial project.
Insurance – is the property properly insured? Does it need to be increased? Here’s a big problem. You buy a commercial property, the insurance is $5,000 a year, and net operating income is 10%. It’s looking good so far except the insurance company is going to stop writing that type of property next year and the next policy is going to cost $25,000 a year.
Property taxes are another thing. Obtain the property tax returns and find out when they have last been reassessed? Property taxes are $12,000 a year. Are they delinquent? If they’re delinquent it means there’s an opportunity there for renegotiation with the seller. Obviously they’re not telling the truth or there are going to be problems other places.
If the property hasn’t been assessed for a very long time and it is going to be assessed when you purchase it, the increase in taxes is going to affect your net operating income. Alternatively, the property may be over assessed. Check to see how the property compares to similar properties in the assessed value? Is it higher or lower? The reason why that’s important is because you may have an opportunity to lower the taxes, which creates more income.
Garbage – is there more than one provider or are you stuck with them? Who does the maintenance? You may not want to do the maintenance. You’ve got to make sure that’s covered. Are there contracts on the HVAC? If not, what would the costs be? Can the water be separately metered? That’s an opportunity to increase cash flow. Gas – can it be separately metered? Bookkeeping and accounting – nobody ever has bookkeeping and accounting on their properties. Do they have a pest control contract?
Go over every expense item and make sure it’s accurate. You’re buying income. If the income does not match, the price must come down or you should exit the deal. It’s really that simple. You’re buying income when it’s income property.
You want to make sure that you get a good title company, and that ALTA will cover easements, encroachments and other title issues. To get an ALTA you need to make sure that the survey is correct. You don’t want to end up with the building on the wrong lot.
Get an appraisal. You need to make sure the value of the building is accurate before completing the purchase.
Obtain a tenant estoppel letter. Have the current tenants sign a tenant estoppel letter that he says I’m paying $1,000 a month, my lease started on September 1, 2009, it’s paid through August 1, 2012 and there are no other agreements written or oral than these terms and conditions. This prevents any surprises such as finding out the $1,000 a month gets whittled down to $700 because they’re giving a kickback for $300 a month for neighborhood watch or something like that. That affects your income.
The mortgage estoppel letter is virtually the same thing. The lender says these are the terms and conditions, and that is in fact the case, particularly a private party.
Get a list of the personal property.
Create a cash flow statement on your numbers, not pro forma.
All documents related to property should be requested and verified.
Commercial Real Estate – Zoning!
Make sure that it’s zoning compliant, building compliant, engineering and ADA compliant. These are all simple questions that you can ask the county.
Make sure it’s zoned property. If you’re expecting to be able to put 18 units per acre on there and you go down to the county and they say you can only put 16, that will affect the value of the property if you’re buying income property that also has the opportunity to add more units. Make sure there are permits and licenses and contracts for the elevator and that it’s been maintained.
The documents listed, the examples, and the references in this article are merely examples. This is not an all-inclusive list of what you need to review before entering into a commercial transaction; this is absolutely for illustration purposes only. You need to consult with the proper professionals when entering into this type of transaction.
American IRA, LLC does not give investment advice. We do offer guidance as to the rules and regulations related to their self-directed accounts and the benefits of different account types so that our clients can take that information to their professionals to discuss the ramifications of various decisions on their individual situation.
For more information, or to explore your options, call American IRA today at 866-7500-IRA (472). We look forward to working with you.