Have you found a property that looks as if with a bit of hard work, could be a great deal?
Occasionally you’ll hear about a commercial property that seems like a good deal with a great location, but either the building isn’t in great condition, or there is a high vacancy rate.
Rather than assume the property is irredeemable, it pays to take a closer look to see if, with a little bit of work, there actually is a diamond in the rough waiting for you to make a profit.
Find The Story Behind The Property
Find out why the property is distressed. Is there an out-of-town owner? Did the property switch hands?
Learning these details about the property will help you buy the property, figure out the financing, and plan an exit strategy.
Unless you have years of experience dealing with a commercial real estate, you should make sure you get help from an experienced commercial real estate investor.
This could be a broker, a mentor, or a fellow investor. Regardless, these types of properties require a thorough knowledge of the ins and outs of what makes a property successful, as well as an ability to navigate the pitfalls unique to this property type that inevitably pop up.
What Is A Distressed Property?
Distressed properties are assets that aren’t performing the way they should.
This can occur in one of the three ways:
- Physically – the property needs major renovations such as a new roof or shows signs of foundational movement. Or, the interior of the property is badly in need of renovation due to delayed maintenance. The building might also be obsolete.
- Financial – the owner has either negative cash flow or the property isn’t making enough money to keep its head above water. It might be as simple as the property is near foreclosure, or that a divorce, death, or other personal issue are preventing the owner from managing the property.
- Legal – Liens or lawsuits are the most common, but it could also be due to a partnership breaking up, building violations that are making it hard for the owner to use the property as intended.
And how do you know if a distressed commercial property is a good deal?
Deciding whether or not a distressed commercial property has profit potential is easier than you think.
First, you’ll need to estimate what the value of the property will be after the issues that led to it being distressed are resolved. Next, calculate the cost of repairing the property. And lastly, determine the amount of money it will cost you to hold the property until it is either sold, or it reaches full potential.
The cost of what the property will be worth after it is fixed up should be greater than the sum of the purchase cost + repairs + carrying costs. In order to figure out how much more the after repair value has to be, take the sum you just calculated (purchase cost + repairs + carrying costs) and divide it by 75%.
after repair value > purchase cost + carrying costs + repair costs
purchase cost + carrying costs + repair costs
The number you get from the above equation tells you what the after repair value should be. Your ARV should be equal or greater to this number.
This number is important not just so you can decide whether or not to invest in the property, but also because this number will affect whether or not lenders will refinance the property.
The rule is that most lenders will give you 75% LTV. So if you can recover the money you put in and still make a profit, then that particular distressed property would be a good deal.
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