This is part 1 of a 4 part series.
It’s embarrassing to admit, but when I was a property manager, I didn’t know how to invest in commercial real estate. In my area, most property managers don’t own investment properties. I’d imagine that trend continues beyond my part of the country. Perhaps it’s because property managers spend so much of their work time around real estate that they don’t want to do it on their personal time. Maybe it’s an employee versus entrepreneur mindset that holds them back. Whatever the reason, it’s a strange reality to encounter.
No one shows you how to invest while you’re working on their properties. They don’t have to do that, now do they? If you ask them, though, most investors would be happy to share their investing stories and insight with you. However, when I was a property manager I didn’t have the courage to ask my own clients how they developed their portfolios. Instead, I remained a guy collecting a check to manage other people’s properties, helping them achieve their dreams while mine seemed like a distant mirage.
After reading Rich Dad, Poor Dad, I wanted to make the commitment to purchasing commercial real estate, but I didn’t know how.
I’d already owned one rental house that didn’t turn out well. You can read the whole story, Growing Your Wealth? Manage Your Perspective, but the only one to blame was me.
Then I met a young real estate broker, Kevin, who talked to me about investing in commercial real estate. He told me about a couple small apartment deals he owned with a partner. I was surprised that a guy who was in his mid-twenties was already buying real estate. I asked him to keep me in mind the next time he put together a deal.
It didn’t take long and Kevin found an off-market property. He presented it to me and asked if I wanted in.
Little did I know, that this would be the deal that would change my spending and investing habits, create a friendship and radically alter my life going forward.
The building was 2,400 sq. ft. and sat one block off of a main retail corner in north Spokane.
Now, when I say one block off, that’s exactly what I mean. It wasn’t on the main thoroughfare, nor the intersecting (but still heavily trafficked) street. Instead, it sat on Rosewood Avenue, a parallel road to the main street, its visibility blocked by larger buildings and restaurants.
This odd strip of retail and office buildings runs for several blocks. This section has survived for more than half a century, helped largely due to the proximity of an exceptionally busy U.S. Post Office and an even busier McDonald’s.
In 2010, Kevin had cold-called the family who owned the building and discovered they wanted to sell. The patriarc had recently passed away and no one in the family wanted to retain the property.
With the help of the family’s attorney, a sale price of $195,000 was reached. The price wasn’t set on a true proforma, but rather what was agreeable between the two parties.
Sometimes, you must do business by the gut. We’d later be able to conduct our due diligence to make sure we were happy with the numbers, but waffling around, waiting to see operating statements at that moment could have allowed someone else to step in on the deal. It was better to tie up the property and kick the proverbial tires once we had control.
A Purchase and Sale Agreement (PSA) was put together and executed.
The building had three tenants.
The first tenant, Spokane Vitamin Supply, was in half the building (1,200 sq. ft.). They’d been in the building since the mid 70’s. The original lease had been lost through time and the ownership group had been changed. We were working with the latest owner who had purchased the business in 1993.
The second tenant, Heads Up Barbershop, was in 600 sq. ft. and they shared a common entryway with the third tenant, a medical billing company who also had 600 sq. ft. These tenants had been in the building for at least nine years each.
All the tenants were on month-to-month leases and they were paying the same rent they had for almost a decade.
We knew we could keep the rents the same and immediately sign the tenants to longer term leases, thereby stabilizing the building’s income stream.
The building appeared to have good bones. It was a concrete block structure that sat on 10,000 sq. ft. of land. A small asphalt parking lot sat out front while a gravel lot was in the back.
We knew the roof was in suspect condition and we’d have to replace it sometime down the road. *Remember this comment because it will bite us in Part III of this series.*
The HVAC (heating / ventilation / air-conditioning) units servicing the building were old and they hadn’t been on a consistent maintenance schedule.
We interviewed the tenants and learned they didn’t have any major complaints about the building, beyond the occasional roof leaks. All of them wanted to stay and agreed to new leases if we would hold their rents steady. It was 2010 and the market was in a trough. We were happy to have tenants in the building, so we weren’t about to rock the boat.
We contacted a local credit union and they agreed to lend us the money to purchase at 75/25% Loan to Value (LTV). This meant that we could borrow 75% of the $195,000 (assuming the appraisal would come in at that – which it did, btw).
That means we’d have to raise roughly $48,750 to buy the property.
Kevin’s idea was that we’d get four partners to throw in on the deal, so each of us would have to raise a little over $12,000 each.
I’ve already told the story of how I raised the money for this acquisition in I Was Broke Because I Wanted to Be. If you haven’t read it, jump over and take a look. You’ll understand how transformational this deal was regarding my spending habits.
Kevin contacted one local investor who immediately agreed to invest. When he told me this, I was shocked. I understood the concept of people putting money into a pot to buy a property, but Kevin was showing me just how quickly and easily it could be done.
In short order, Kevin had another investor for the building and suddenly we had all the money ready to go.
We contacted an attorney and formed our Limited Liability Company (LLC) to purchase the property. The LLC provides a level of legal protection in case someone decides they want to sue the property for something. There are many reasons someone may want to do this, from a slip and fall to a contract dispute. Regardless, an LLC or other corporate formation should be seen as a must.
Our closing was scheduling at the end of April 2010. At this time, new five-year leases with all three tenants were also executed.
We immediately contacted a local HVAC company and set up a quarterly service plan for the HVAC units. Due to their age, we were worried about losing one or more of the units early on. However, due to regular maintenance we’ve gotten seven strong years of performance from the units. There have been a couple major repairs done, but nothing that’s risen to the level of needing a full replacement.
Address Deficiencies Early
We should have attempted to negotiate a lower purchase price based upon some of the deficiencies we initially found in the roof and the HVAC system. The roof would cost us later on as I’ll detail in an upcoming post and the HVAC units were extremely old.
However, we were still new in our investing cycle. This was my first building and Kevin’s fourth. Even though we had identified the potential issues, we didn’t realize then that we could go back to the seller to renegotiate the price.
We may not have gotten it lowered, but you won’t know until you try.
Today, if we were faced with a similar scenario, we would definitely approach a seller with our concerns and request a price modification.
As Kevin is fond of saying now, “The answer is always no unless you ask.”
Don’t Let Fear Stand in Your Way
This building has led to more than a dozen other commercial building purchases and more will surely follow. However, I sat on the sidelines for a lot of years due primarily to fear.
I wanted to buy commercial real estate, but claimed not to know how. Yet, the process is fairly simply and very similar to buying a residential home. I made it complicated in my head because fear had run rampant.
That is why teaming up with someone for that first purchase was a wise choice. My partner’s confidence carried me when I was scared. I examined the numbers, walked the property and everything looked okay, but I was still afraid to pony up the money and put my name on the line. Once I did it, though, my life changed for the better.
I’m glad I took that chance and I continue to look for opportunities to repeat that experience.
Ready for the next section?