Expert: Phil Nicols - 2/6/2009

Question
I am overall quite familiar with investment properties as I have owned, investigated and do still different types. Most of my experience is in Multi-res though or single user buildings.

I have come across an opportunity to privately purchase  small industrial mall. The pitch looks good, but am just wondering what sort of cap rate (roughly speaking) would be applicable in todays market.

It is about a 20,000sq-ft 12 tenant building. It is fully leased and has been for some time. In fact, 2 of the majour tenants have been there for 10 years + and one just renewed for another five year term. The property is in a good leasing location in the golden horseshoe, the tenant mix is nice, the building is in good shape etc. There are really no extenuating circumstances which might affect the price. It is a pretty straightforward investment.

Also, as I have not bought anything recently, what are market rates for financing like on this type of property. I will be putting 35% down on the purchase price of around $1.2mil. I have a strong covenant.

Your thoughts and opinions wwill be most helpful.

Answer
Michael

Im going to be brutally honest and its not what you are going to want to hear but someone has to be Devils advocate in this case cause all you can see is through the rose coloured glasses right now. I have charged over $2000 for a 2hr appearance to talk about just this...

On the outside its looks like a fantastic deal however GTA covers a large area and its impossible for me to speculate on that particular property without any more details.

Properties on Queen west Toronto for instance are invaluable! even in a down market, they still command great rental rates, yet on the VERY SAME STREET, EAST of Yonge, you cant give a property away! So how could I possibly speculate on the value of your investment based on "GTA"? I'm a hard worker but by no stretch a psychic.

based on the price, I can guarantee that its not in Toronto area.

lets get something else straight... its not a "mall". This implies a building with interior hallways and generally national tenants and you just can't do that in 20,000sf. what you are buying is a "strip plaza" at best if not a hybrid of several components spliced together. big difference in the cost to build, cost to buy, cost to develop, cost to run, taxes and of course, the rents.

theres all kinds of other factors as well. sure the tenant may have been there for 10 years...

first - don't put ANY strength on the lease at all. bankruptcy OVERRIDES all Leases and all they have to do is push that button and you end up in a pecking order behind realty tax collector, utilities and other encumbrances.

the only strength in a lease is if the tenant has something to loose, like, if you have Tim Hortons corporation on the head lease and the operator is only a sub-lease. if you area dealing with a mom and pop shop (which Im sure you area based on the price) they can walk just as soon as breath.

unfortunately, the commercial real estate market has been split like everything else in recent years. You've got the haves and the have not's and very little in between.

either you are going to deal with the bottom tenants that might or might not make rent, or you are going to buy into Corporate Canada -- typically invest in REITS who have the money to buy real estate with A Class tenants -- those with something to loose.

the best buildings WILL NOT accept mom & pop shops as tenants - only national name brands and you are not buying those buildings for 1.2 million.

Market rates vary. they get you in the door at 4 or 5% but then even after a signed commitment, Ive seen banks hit the buyer, at the very last second with, "well, we'll still do the deal but its going to cost 7% and more DP becuase of "risk management"

financing makes or breaks deals. this is why its important to have a good team behind you. good broker with local market knowledge, and financial team that you can "trust" or have some rapport with.
Looking at it, and talking about it represents about 10% of what you need to do to make the deal.

everyone wants to make a deal right now and they will tell you anything to get you in the door. People give car salesmen a bad rap but the fact is that large "prestigious" corporations like Banks, who we are supposed to trust, are the worst! Banks are in the drivers seat as usually are cause we need their money but they want lend it on their terms. BUT, they realize, if they put their cards up front, you will not go to them and seek competitors deals - so they all go to "salesman school" where they all learn the same tricks to get you in the door.

then they look at your deal. If you have 30 days conditional period for due diligence, they will not commit to you until the 29th day so you will not have a chance to shop the deal around. Once they know you have run of time and you want the deal, thats when they stick it to you, with up front fees, back end fees, raising the rate, lowering the amount they will give you -- those kind of games.

you are paying 1.2m - you have to ask yourself, if I invested 1.2m in something else, can I get a return without the headaches, without the exposure of having a tenant pack up at midnight.

if you believe in real estate, why don't you invest in a REIT where you have no management issues? this way you get to invest in Prime locations, triple A tenants and experience management -- as well, your money is also liquid. much easier to sell stocks than real estate -- and you are investing across a portfolio not putting your eggs in the basket of ONE property - far less risk and likely better return.

I have clients that are pulling what hair they have left out of their head, trying to figure out how they are going to pay the property tax bill with no tenants.

if you are buying real estate to fix a tax problem, thats another story but you are better off to speak to a commercial accountant for that advice.

I know this is not what you wanted to hear, but far be it from me to advise you on something I have not seen or investigated and I don't think I would be benefiting you at all just to agree with you and say sure go buy it. I'm pointing out the shortfalls for your info cause you asked.

best, Phil

PS Michael, you might want to check this out...

http://www.concreteequities.com/