Complete Guide to Real Estate Tax Liens and Foreclosure Deeds Learn in 7 Days Investing Without Losing Series_10 docx

Does your prospective commercial fixer-upper favorably satisfy these fac- tors? If so, you’re ready to move on to the next level: due diligence. If not, consider finding another deal for now. Perform due diligence Due diligence is the process of doing your homework on a potential invest- ment. You’re looking to find out whether it’s a good buy, an average buy, or a bad buy. Because we have dedicated Chapter 6 to the subject of due dili- gence, we recommend that you review it again. Due diligence is not only a fact-gathering mission, but it is also a mind-set. You must think like an investigator on one of those detective television shows. Leave no stone unturned. Expect the unexpected. Expect drama. Expect the twist in the story. The one thing you want to avoid is a surprise ending, right? A proper mind-set also means being “present” with what’s going on around you. You need to be as distraction free as possible when going through the due diligence process. What are the consequences of being distracted during due diligence? Not good, that’s for sure. Not being present may cause you to overlook important property expenses or not follow up on a severe physical defect in the property’s structure. The due diligence process usually has three areas of focus: physical inspec- tion, financial investigation, and legal inquiries. In the following sections, we touch on these topics as they pertain to commercial fixer-uppers, but we add another area: sales and marketing strategies, which are often overlooked. Physical inspection Hire a professional property inspector to do the physical inspection. These professionals are trained to spot apparent and potential problems. They’ll get on the roof, check out the building’s foundation, walk through every unit of occupyable space, including storage and garage areas and laundry facilities, check for building code violations, and see if the electrical and plumbing sys- tems are up-to-date. Keep in mind that during a physical inspection, your goal is to take note of every broken piece of the property that’s going to need fixing. For example, jot down if there is evidence of a roof leak or if a section of the sidewalk is a safety hazard and needs replacing. Remember, your goal is to buy at a good price, fix it up, lease up, and sell. Knowing how much the fix-up is going to cost is a major piece of the puzzle. After you have your list of items that need fixing, you’re in a position to add everything up to see if the costs outweigh the benefits of buying. 256 Part V: Kicking Your Investing into High Gear 22_174913 ch14.qxp 11/21/07 4:36 PM Page 256 During the inspection, it’s a good idea to have your roofer and general con- tractor there, walking around with the property inspector. An inspector will give his best guess on what it will cost to have a roof replaced or what it will cost to have siding replaced. With the roofer and general contractor there, you can get more accurate costs immediately. Although a professional property inspector can give you the overall picture of the property’s condition, you should consider bringing in a specialist if the inspector’s report turns up a potential problem that’s beyond his experience. Financial investigation You’ll run into different financial scenarios with a fixer-upper than you would if you were buying a normal, ready-to-take-over commercial property. First of all, because the property is distressed, the financial records will show it. Typically, the income is much lower than its potential, and the expenses are higher than normal, proportionally. Don’t be surprised. Second, expect the financial records to be incomplete, nonexistent, and maybe really unprofes- sional looking. This is why it’s a fixer-upper. This is where you make your profits. When you do your financial investigation, crunch the numbers as-is by evalu- ating the cash flow of the property in its current condition. Of course, you’ll see a horrible, negative cash-flow condition. Make a note of that negative cash-flow number. Now crunch the numbers as if the property is fixed up and 90 percent occupied or at market occupancy with great tenants. What does the cash flow look like? Hopefully it’s great. Make a note of that positive cash- flow number. See the big difference between the two? Now, you have to ask yourself these questions: ߜ How do I go from that huge negative number to that great positive number? ߜ How do I bridge the gap? Is it attainable? ߜ How long will it take and how much will it cost? All of these issues are discussed later in the chapter. Legal inquiries Everything that you read about “legal” due diligence in Chapter 6 applies here. However, with fixer-uppers, you need to look at a few things a little more closely. First, because the property is distressed, we would be concerned about liens from contractors, subcontractors, workers, and materials suppli- ers. Make sure that your purchase contract agreement states that the seller is responsible for clearing up all liens placed against the property before closing occurs. Also pay close attention to building code violations. Because 257 Chapter 14: Making a Success Out of Commercial Fixer-Uppers 22_174913 ch14.qxp 11/21/07 4:36 PM Page 257 the property is distressed, what corners did the owner or management cut? Last, but not least, pay extra attention to the insurance policy, and obtain a claims history report. You’ll find out about things such as past fires, past water-damage claims, and prior tenant claims. Sales and marketing strategy Part of your due diligence is to come up with a sales and marketing plan to lease your spiffy new property with great tenants and great leases as quickly as possible. Just as any new forward-looking, successful business has a busi- ness plan, your project needs one too. This part of due diligence is often overlooked because the person managing the update has his hands full with those challenges. And most great project managers don’t have a salesperson’s mentality. They’re usually very analytical, but not the salesperson you need to have on the team. If you’re creating a plan for a retail center, start off by asking these questions: ߜ How are other retail centers doing in this area? ߜ Is the population trend upward or downward? ߜ Is there job growth in the city? Do enough research to solidly quantify any trends that you discover. Next research and find out if there will be a strong market for your fixer-upper after you finish. Will your finished product be in demand? Do this work upfront. Then figure out the most effective ways of marketing your completed fixer-upper. Implementing a strong plan with the right salespeople on the front lines makes all the difference. For more help on this topic, check out Marketing For Dummies, 2nd Edition, by Alexander Haim (Wiley). Before fix-up and after: Bridging the gap to payday After your due diligence is complete, you have to make a decision. Do I pull the trigger on this deal? Your due diligence holds the answers to some key questions: Can I take this property in its “before” condition and transform it into its desired “after” condition? Can I do it profitably and within a reason- able time frame? In other words, do I have the skill, know-how, and resources to take this mess of a property, this great opportunity, and cross the bridge to a property that attracts the best tenants, gets good lease rates, improves the area, and makes me money? Here are tips for bridging that gap: ߜ Know your break-even point. Know how much income you need to bring in to break even after paying operating expenses and the mortgage. Get to this point as quickly as possible. (We discuss breaking even in detail later in the chapter.) 258 Part V: Kicking Your Investing into High Gear 22_174913 ch14.qxp 11/21/07 4:36 PM Page 258 ߜ Find out the cause of the distress. Find the root causes of how the prop- erty got into trouble. Property problems go two to three levels deep. For example, if the property’s distress is blamed on a weak rental market (level 1), it’s probably because the owner is marketing to the wrong type of tenants (level 2). The owner may be misdirecting her marketing because she’s out of tune with what’s happening in the market today (level 3). As you can see, each level has a root cause (as well as a solution). ߜ Rate the seriousness of each problem. After examining the causes of the distress, prioritize each one on a scale from one to five, with five being very serious. Immediately address the fives first, and then work your way down. ߜ Total your financial needs. You need to figure out as best you can how much money you need to purchase and fix up the property. Your total should include any long- and short-term loans, including construction loans, rehab loans, bridge loans, hard money loans, or lines of credit. And as a safeguard, add a cash reserve. ߜ Figure out how long it will take to complete your game plan. Although this may be difficult to pinpoint, sketch out as best as you can how long it will take to acquire, fix up, and sell the property. Don’t just throw out a number of months or years. Instead, make an educated guess. For instance, if the purchase process takes 3 months, the fix-up takes 12 months, and positioning and selling takes 6 months, you’re talking almost 2 years for the project completion. The months can really add up quickly. It’s best to be on the conservative side. ߜ Decide who’s going to do the work. Who’s on your team? You’ll have to develop your team of professionals — general contractors, attorneys, property managers, leasing agents, maintenance personnel, project man- agers, accountants/bookkeepers, and various other folks. Determining your break-even point One of the first things we like to know before jumping into a deal is how much income we need to bring in each month to at least break even in cash flow. It’s stressful owning and managing negative cash-flow properties, so the question is, where do you need to be occupancy-wise to at least break even? You want to get to this condition as soon as possible. Getting to the break- even point allows you to predictably turn the corner to positive cash flow and profitability. Here’s a quick and easy formula to use to figure out your break-even point: 259 Chapter 14: Making a Success Out of Commercial Fixer-Uppers 22_174913 ch14.qxp 11/21/07 4:36 PM Page 259 1. Calculate your potential gross income. Potential gross income is defined as the most income the property can make when it’s 100 percent occupied. For example, if you have 60 apart- ment units renting at $555 per month each, your potential gross income is 60 × $555 or $33,300 per month. Now, multiply by 12 to get the annual total, which is approximately $400,000. 2. Calculate your total operating expenses. Add up all of your monthly expenses, including taxes, insurance, mainte- nance, repairs, utilities, landscaping, accounting, management fees, salaries, and so on. Then multiply that number by 12 to get your annual total. 3. Calculate your total mortgage payments for 12 months. This is called this your annual debt service. You can use this formula to find your break-even point: Break-even occupancy % point = (operating expenses + annual debt ser- vice) ÷ potential gross income × 100 Here’s a quick example: Suppose the fixer-upper is currently 50 percent occu- pied. Say at 100 percent occupancy, the property brings in $400,000, and the operating expenses run you $185,000. The annual debt service is $95,000. See the break-even point calculation below: Break-even occupancy % point = ($185,000 + $95,000) ÷ $400,000 × 100 = 70% This means that when the property reaches 70 percent occupancy, it will break even. Below 70 percent occupancy, the property will operate in negative cash flow. Any occupancy above 70 percent will produce positive cash flow. In this example, the property is currently 50 percent occupied. After it reaches 70 percent occupancy, it will have a positive cash flow. Given these numbers, you need to ask yourself these questions: How long will it take to reach a 70 percent occupancy break-even point? And can I support the property finan- cially until it reaches 70 percent occupancy? Creating checkpoints for the renovation process It’s a given that when you purchase a fixer-upper you’ll have to do some work on it, and for that, it’s best to have timely checkpoints. Start your checkpoints by identifying the main pieces of the fix-up puzzle: financial, rehabilitation, property management, and lease-up. 260 Part V: Kicking Your Investing into High Gear 22_174913 ch14.qxp 11/21/07 4:36 PM Page 260 You need to think about many questions and tasks to establish checkpoints for your commercial fixer-upper project. What follows are the various check- points to consider for putting together each piece of the timeline puzzle. Financial checkpoints You need to answer three questions to come up with a financial timeline. If you have all the necessary funds to fix up the property, you’re all set. But if you need to obtain the money from other sources, such as a lender or investor, you need to plan accordingly. Ask yourself these questions: ߜ How much do I want to profit and in what time period? You may have to expand your rehab tasks and spend a little more to achieve a greater profit. ߜ How much is it going to cost me to fix up the joint? ߜ How fast can I get a hold of the money I need? Rehabilitation checkpoints When planning the rehab work on the property, keep these points in mind: ߜ Identify the rehab items that will give you the highest rate of return on your rehab dollar. Start on those first. For example, if all you need to do is minor drywall work to make your downstairs office space lease ready, and there is a ready market for that space, do that first. Curb-appeal improvements provide the highest rate of return on your rehab dollar. The easiest way to fix up and turn around a property is to make it look “pretty.” It’s amazing what a little sprucing up at a retail strip mall does to increase its occupancy and desirability. Before you start implementing your ideas for marketing, do your most important curb-appeal-type tasks. You can’t sell on promises. Rarely will a tenant sign a lease because you verbally promise that the property will look “pretty” within a few months. ߜ Set up a spending budget with enough detail to show how many tools and supplies you plan on using. Include items like rags, towels, and rolls of masking tape. You need to be that detailed. You may not know exactly how many rolls of masking tape you’re going to need, but have them in the budget. Simple cost overruns can turn huge in a heartbeat if you don’t take every single line item into account. Be a penny pincher. ߜ Get your skilled helpers ready to get to work. Do they have their own tools? Will materials and supplies be ready for them? Do you have enough help to get the job done in the amount of time required? Have you budgeted for a little extra just in case you need more help? ߜ Have a system of monitoring progress of the rehab work. We use pro- ject management software. Many choices are available online. 261 Chapter 14: Making a Success Out of Commercial Fixer-Uppers 22_174913 ch14.qxp 11/21/07 4:36 PM Page 261 Property management checkpoints Keep these issues in mind when determining your property management needs: ߜ Do you have extensive property management experience? If not, hire someone who does. This is a critical part of the fix-up process. The property manager makes sure that all the projects and the overall time- line stay on track and checkpoints are checked off. ߜ Make sure that your means of reporting information or obtaining information from the property is consistent and reliable. We use Web-based property management software for all of our properties. Information is available to us 24/7 with a touch of a keystroke. So at any- time, we can find out about project accounting costs, budget monitoring, profit and loss reports, payable and receivable reports, tenant informa- tion, and maintenance status. Depending on the project, we create our own spreadsheets by using a program such as Microsoft Excel. For more expansive projects with multiple people and where sharing is involved, we’ll use an online program such as Microsoft Groove. ߜ Put the focus on customer satisfaction. Keep in mind that the purpose of fixing up the property is to attract paying tenants and keep them for a long time. To measure customer satisfaction, look at the property’s tenant turnover ratio. A turnover ratio of greater than 70 percent means that 70 percent of your tenants are leaving within 12 months. Not good for your bottom line. Chances are that they’re leaving because they aren’t being served satisfactorily. Lease-up checkpoints When it’s time to starting leasing, consider these points: ߜ Be ready for the Saturday drive-by and visit. Put on a good first impres- sion for the person who’s just driving by. Make sure the grounds are clean and well landscaped, keep your signs and buildings painted, and have convenient parking. It’s a lot easier to lease up your property if you can get potential tenants to come through the front door or call the number on the sign outside. We can’t overemphasize enough how impor- tant it is to have the completed fixer-upper look dazzling from the outside in. ߜ Set your marketing efforts to the type of tenants you want. Know who you want as your tenants. Know their socioeconomic status, income, and lifestyles. Then figure out where to find these people and focus your marketing strategy there. If your newly renovated property is ripe for doctor’s offices, forget about marketing in apartment rental guides. If your newly renovated downtown office building is ready for lease-up, consider hiring a leasing company that specializes in placing downtown office tenants. 262 Part V: Kicking Your Investing into High Gear 22_174913 ch14.qxp 11/21/07 4:36 PM Page 262 ߜ Motivate your marketing and leasing staff with money. We routinely give bonuses to our leasing agents as each new lease is signed. Rewarding our leasing agents with a bonus equal to half of the first month’s rent isn’t out of the question when we need to be really aggressive. Don’t be cheap. Being cheap can be expensive! ߜ Check out the competition. When was the last time you went shopping? No, not grocery shopping. When was the last time you went shopping to peek at your competitor’s offering to the public? Before you lease one bit of any space, make sure you perform lease and rent surveys of your com- petition. In addition to finding out what they’re charging for rent, see if they’re giving out incentives such as one month rent free or a reduced lease rate if the tenant signs a longer lease. What amenities do your com- petitors have that you don’t? Being a shopaholic is encouraged here! Avoiding Headaches and Pitfalls (Or at Least Minimizing the Pain) Experience is the best remedy for the headaches of taking on a commercial fixer-upper. We wish we would have had a book like this to lay out the groundwork for us when we first started. We’ve heard that mentoring means getting wisdom without the pain. In an effort to offer you some mentoring, here are a few nuggets about how to avoid common pitfalls (yes, ones we’ve experienced ourselves). We also include some tips for hiring out your headaches — oops, we mean projects. Recognize hopeless situations Not every commercial fixer-upper can be fixed. That’s right. Some deals out there are just too far gone to make a profit from. Sometimes you can spot them upfront, but most times you’ll have to go through some due diligence to really find out. Here are a few signs and situations that tell you that your prospective fixer-upper deal is hopeless and you should move on to the next opportunity. Avoid obsolete properties In commercial real estate, properties can be deemed obsolete in three ways. When the property is obsolete, it can be very difficult and very expensive — and sometimes impossible — to make right. An enormous loss of real value can occur if a property becomes obsolete. Here are the ways in which a prop- erty can be obsolete: 263 Chapter 14: Making a Success Out of Commercial Fixer-Uppers 22_174913 ch14.qxp 11/21/07 4:36 PM Page 263 ߜ Physically: This is a loss of value due to Mother Nature and old age. Or the property is just plain worn out. Physical deterioration is another name for it. A property with a foundation made out of crumbling bricks and located in an earthquake zone is a good example. ߜ Functionally: In this category, a property can’t be used or it loses value because of its poor design or lack of modern facilities. An example would be a warehouse that doesn’t have enough electrical power to accommodate today’s advanced electronics and circuitry. ߜ Economically: Here a property loses its value because of external forces, such as a change in zoning or changes in traffic flow. A good example would be having an airport or freeway constructed too close to your property. Another great example could be the loss of a major employer in your immediate area. Avoid an owner who doesn’t want to play If the owner isn’t serious about selling or isn’t willing to be reasonable, don’t fool around. Move on to the next opportunity. Maybe give the reluctant owner a call 30 days from now to see if his motivation has changed. Avoid properties that have too much debt We have seen properties that have been refinanced many times and now have huge mortgage balances on them. The large mortgage payments have sucked the cash flow from the properties and now the owner wants to sell. But here’s the problem: The amount we’re willing to pay for the property is lower than what is owed on the property. Unless the owner can do a “debt workout” with the lender, we’re passing. Avoid buying properties with bargain-bottom prices Don’t invest in an area experiencing a downturn. The price is low for a reason, especially in areas where the economy is declining. Because typical real estate cycles run on ten-year curves, you may have to wait for ten years for a turn- around or peak, if one happens at all. Hire good contractors (and think like one when you do projects yourself) Contractors make a living by estimating the costs of a project, adding extra to it for profit, and then doing the work. As a commercial fixer-upper investor, you should think the same way. When a contractor takes too long to finish a job, he’ll start “running in the red,” meaning that he’s no longer making a profit. When you take too long to complete a fixer-upper, you can easily wipe out your profits. 264 Part V: Kicking Your Investing into High Gear 22_174913 ch14.qxp 11/21/07 4:36 PM Page 264 When you’ve done all the right things — bought low, fixed up under budget, and improved the financial situation — don’t hesitate to get out. Don’t wait around for new challenges and problems — they’ll cost you your profits. Sell as quickly as possible. Think like a contractor: get in, do good work, and get paid. As for hiring a contractor for your commercial fixer-upper, it’s different than hiring someone to remodel your home’s kitchen. Commercial real estate investing is a business, so you need to think like a highly skilled and profes- sional businessperson. We may sound like a broken record, but treat your commercial real estate business like a business and hire only the best and most cost-effective people or companies of the highest integrity. Don’t take any shortcuts and never compromise. Your future will thank you for it. Be leery of contractors who ask you to make payments in their personal name, ask for cash only, or want large payments upfront. All of these are red flags, and they indicate that the contractor’s license may have been revoked or sus- pended, that his insurance is cancelled, or that he’s having financial problems. 265 Chapter 14: Making a Success Out of Commercial Fixer-Uppers Why commercial fixer-uppers will be around forever Want a career with never-ending possibilities and an endless flow of money-making deals? Commercial fixer-uppers will always be around as long as real estate exists. The real estate cycle continuously creates distressed proper- ties and distressed owners. At the peak of the cycle, where you have seller’s market condi- tions such as high price and low inventory, you find buyers who have gotten in over their heads because of over-enthusiasm and lack of experi- ence. Within a few years (sometime less) of owning the property, these owners want out at all costs because of distress. So here’s your start of the fixer-upper opportunities. At the bottom of the cycle are buyer’s market conditions. High inventories and low prices are signs of the times. In this market, you have countless opportunities. Somewhere in the world, a buyer’s market always exists. We see quite a bit of “uneducated” money chasing after the same properties a seasoned and experienced investor would. The unedu- cated investors end up paying too much and buying with unrealistic investment goals. This results in two things: First, prices get inflated. Second, these same owners become owners of distressed properties over time because they’re in over their heads. Do you see the cycle? For those of you who want to invest in commer- cial fixer-uppers, more money is available to you than ever before in the history of real estate investing. Lenders want to lend you money to fix up commercial properties that will enhance an area or city. Every time you fix up a property, you add jobs to the city and increase the tax revenues. 22_174913 ch14.qxp 11/21/07 4:36 PM Page 265 [...]... ch15.qxp 274 11/21/ 07 4: 37 PM Page 274 Part V: Kicking Your Investing into High Gear Finding the Best Places to Invest in Land One of the best places to develop land can often be right in town Do you know of any areas of open land that may be big enough for five to ten houses? These are called infill projects Another good place to invest in land is in the direction in which the city is expanding For example,... Identifying the pros and cons of investing in land ᮣ Paying attention to your surrounding market ᮣ Surveying the three Ps of successful investing ᮣ Teaming up for your land development project ᮣ Negotiating for extra closing time ᮣ Dealing with zoning and approvals for your project ᮣ Working with bureaucrats and making connections at city hall L and development is a way to take a small amount of money and. .. property You can sell to another builder, hire a builder and manage the project, or build it yourself 23_ 174 913 ch15.qxp 11/21/ 07 4: 37 PM Page 273 Chapter 15: Land Development: The Heart of Commercial Real Estate Investing in Land with a Team Yes, we understand that it’s difficult to invest in land on your own, which is a key reason why our commercial investing trainings keep getting bigger and bigger Our... has utilities in place, is worth much more Knowing Whether You’re in the Right Market When you’re looking for the right piece of land to develop, you need to pay attention to what surrounds the piece of land that you’re interested in For instance, ask the following questions: 269 23_ 174 913 ch15.qxp 270 11/21/ 07 4: 37 PM Page 270 Part V: Kicking Your Investing into High Gear Changing zoning Several of... out of town every week from Sunday night through Thursday His marriage was looking pretty shaky and his kids hardly knew him Rob read our book Making Big Money Investing in Real Estate without Tenants, Banks, or Rehab Projects, and decided to quit the corporate rat race and join our Residential Mentoring Program He began investing in single-family houses and, over 18 months, worked up to the point where... development team), how best to negotiate, and how to get your deal approved The Pros and Cons of Investing in Land Land development can be a wonderful thing, but it can also be quite challenging at times In this section, we show you both sides 23_ 174 913 ch15.qxp 268 11/21/ 07 4: 37 PM Page 268 Part V: Kicking Your Investing into High Gear The pros When you take a 5-acre piece of raw land that’s worth a million... produce income to cover these expenses How can you buy time until you’re able to fully develop the land? Our favorite way to do this is by using options to control your ability to purchase the property without actually having to make payments on it An option is a fee paid to the owner That fee allows you to have the property under 277 23_ 174 913 ch15.qxp 278 11/21/ 07 4: 37 PM Page 278 Part V: Kicking Your Investing. .. other students were getting involved in commercial real estate He had been happy up to that point simply investing in single-family homes Rob went to his father -in- law, David, who was a commercial broker and said, “Pop, I want to do what you do Would you be willing to take me under your wing?” Fast-forward two years Rob has found a 12-acre piece of land that appears to be located in the path of progress... would.” By doing this, he was able to extend the time to closing from 60 days all the way to 9 months And during those nine months, Roger was able to find a bank that would loan him $5 million and also line up investors who put in another $5 million This gave him a total of $10 million to work with He now had the money to cover the payments on the property during the next several years in case he didn’t... end up being able to sell 43.5 lots Using this tip, you just picked up an extra 31⁄2 acres of land for free How’s that for a return on your investment? 271 23_ 174 913 ch15.qxp 272 11/21/ 07 4: 37 PM Page 272 Part V: Kicking Your Investing into High Gear Many cities have an outer development boundary that’s drawn on the planning maps This boundary is outside the city line, and it defines the areas in which . 23_ 174 913 ch15.qxp 11/21/ 07 4: 37 PM Page 272 Investing in Land with a Team Yes, we understand that it’s difficult to invest in land on your own, which is a key reason why our commercial investing. Chapter ᮣ Identifying the pros and cons of investing in land ᮣ Paying attention to your surrounding market ᮣ Surveying the three Ps of successful investing ᮣ Teaming up for your land development. right people to work with. 273 Chapter 15: Land Development: The Heart of Commercial Real Estate 23_ 174 913 ch15.qxp 11/21/ 07 4: 37 PM Page 273 Finding the Best Places to Invest in Land One of the