The Riches Back To Rags Story Of Today\’s Retail Property Owner \”Will Opportunity Be Knocking On Your Door?\” Part 3.

The Riches Back To Rags Story Of Today\’s Retail Property Owner
\”Will Opportunity be Knocking on your Door?\” Part 3.

{4 minutes to read} 

  • Sam Liebman
  • December 11, 2021

My opinion is that soon lenders will be inundated with a massive amount of foreclosures resulting in a flood of offers to purchase retail properties at bargain basement prices.

 

Assume the owners described in Parts 1 & 2 of this article chose to stop the bleeding, accept the loss of their entire investment including their loans and go on with their lives. Rather than a prolonged foreclosure and since the mortgage was nonrecourse the lender accepted the property back.  

 

The lender now has a property on their hands that pre-covid was worth $3,000,000 but is now worth substantially less. Assume the unamortized mortgage balance is approximately $2,000,000. 

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Now the bleeding starts for the lender.

  • The lender has lost months of interest and principal because the deferrals previously given will never be paid. 
  • The lender is no longer receiving any debt service payments. 
  • A foreclosed property on the lenders balance sheet is not a positive for the lenders regulators. 
  • The lender still needs to pay the operating costs, along with real estate taxes with the only source of revenue coming from partially empty shopping center. 
  • During the pandemic two of the tenants renegotiated their rents from $35 per SF down to $25 per SF. The vacant space is projected to be rented at $25 per SF. At a 7% cap rate the reduced rent resulted in a decrease in property value of $857,143 ($35 – $25 x 6,000 SF)/7%).
  • The 2 existing restaurant leases expire in less than 3 years resulting in no tenant stability with the possibility of additional vacancies in the near future.
  • The immediate area is inundated with retail vacancies. Less demand has caused rental rates to plummet.
  • There could be another Covid related incident causing the other restaurants to stop paying rent and/or close. 
  • The lender will need to incur a broker fee to sell the property.
  • To lease the vacant space the lender will need to incur additional expenses of approximately $120,000, as detailed below.

 

The bottom line is that now it’s the lender who wants to stop the bleeding!

At What Purchase Price Will The Acquisition Make Sense?

What purchase price would make this acquisition a prudent investment? The lender is now offering the mortgage for sale on an “as is basis”. 

 

Given the risk, I would need to purchase the property at a price that would provide me with a 10% – 12% cash-on-cash return on my total cash investment as well, as providing huge upside potential.

 

Below is a summary of the tenancy:

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Since the leases will all be rented on a triple net basis, the total projected revenue of $150,000 also represents the Net Operating Income (NOI) of the property when fully leased. 

 

Assuming the vacant space can be rented 4 months after purchase (@ $25 per SF); the new purchaser will need to incur the following additional leasing and other expenses.

 

  • Loss of 4 months’ rent while the space was vacant – $16,667.
  • Loss of 4 months unreimbursed operating expenses and taxes for the vacant space – $6,667.
  • Broker fees of approximately $15,000.
  • Free base rent period of 4 months for the new tenant – $16,667.
  • Tenant improvement allowance of $25 per SF – $50,000.
  • Approximately $15,000 for repairs and deferred maintenance.

 

Total – $120,000.

 

The prior owner paid $3,000,000 for the property. But that was in a much more favorable environment and when market rents were $35 per SF and not $25 per SF. 

 

At a 10% cap rate, the properties NOI when fully rented would compute to a property value of $1,500,000 ($150,000/10%) or a 25% discount of the mortgage balance and a 50% discount from the previous purchase price.

 

It will be extremely difficult for a new purchaser to obtain a mortgage unless they are willing to put down a substantially down payment of 40% – 50% of the purchase price and provide a full personal guarantee. Even then it will be hard.

 

Acquisition Summary:

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The projected cash-on-cash return on investment would be as follows :

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The above illustration doesn’t include a 3-6 month interest reserve or repair escrow lenders will generally require further decreasing the cash-on-cash return on investment.

 

Bottom Line:

 

Given the assumptions above I wouldn’t pay more than $1,300,000 – $1,400,000 for this property. My decision would depend upon location, store sizes, street and road traffic, property condition, zoning, tenant class and stability, etc.

The Potential Upside

A prospective purchaser would be acquiring a property whose value 3 years ago was $3,000,000. Each individual purchaser needs to make their own assumptions regarding the future of the investment. Below are some factors to consider. 

 

  1. Will rents increase in subsequent years?
  2. Will the 2 tenants with expiring leases renew? At what rents, terms and conditions?
  3. If a tenant vacates in the future there will be substantial costs incurred to release the space.
  4. Will cap rates continue to increase or decrease?
  5. Will interest rates increase in the near future?
  6. Will lenders be more inclined to lend to retail properties at more favorable rates, terms and conditions?

 

Perhaps more tenants will be able to succeed because of the lower rents. Hopefully in the near future the pandemic will be just a bad memory. Should this become a reality it should provide a more stable retail environment that lenders will embrace leading to more competitive financing opportunities and lower caps rates. This situation would provide an opportunity to refinance the mortgage at lower interest rates and possibly reduce the purchaser’s capital investment.

 

 

In my opinion there soon will be many properties available for purchase at bargain basement prices. This opportunity will provide new investors with high cash-on-cash returns on investment and the potential for significant appreciation in the future. 

 

In the early 1990’s and then again in the early 2000’s, I purchased many properties in foreclosure at over 50% of the mortgage. You can too!

 

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Sam Liebman is founder and CEO of WealthWay Equity Group LLC, a New  York-based private equity and real estate development company. He has owned substantial interests in over 70 properties during the past 30 years, ranging from multifamily communities, office buildings and shopping centers, to the ground up construction of a luxury 21-story condominium development in Manhattan. He is also CEO of Rolling Cash Realty, Inc., a real estate management company, as well as a partner in Tepper & Co., a certified public accounting firm. His new book is Harvard Can’t Teach What You Learn from the Streets: The Street Success Guide to Building Wealth through Multi-Family Real Estate (Made for Success Publishing, Jan. 11, 2022). Learn more at samliebman.com

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