Secrets for Buying Distressed Commercial Real Estate - Part 3 of 3

As promised, more secrets.

Secret # 6 – The Downside is Upside

This kind of ties in with a couple of secrets I’ve already mentioned.  When you get excited over a piece of commercial real estate, you’re excited about the “upside potential” of it.  You can run it better than than the last schmo.  You can make the changes to turn this puppy around.  Well, maybe you can but the odds are against you.  Even if you’re not in that boat, ask yourself how much of the value that you’re placing on this property is in the future when it’s time to sell?  Will you find the long lost fortune of King Midas when you’re selling that property at the closing table?

There’s only one king here.  Cash flow is king.  If it’s not giving you the return on investment when you buy it, you’re just gambling.  Think about it… the price your real estate will be worth in “x” years into the future is completely out of your control… just like that roll of the dice.  All you can do is control the here and now.  That means you need a good cash flow return, not upside potential, appreciation or a high reversion sale price.

Secret # 7 – Your Investment Will Destruct If You Can’t Reconstruct the Operating Statement

This is a big one.  If you don’t know for sure how much income a property is generating, what its expenses are and its net operating income, take the walk.  This is especially true of real estate where a business operates such as marinas.  If you base your cash flow projections and return on investment on an income statement that you can’t verify the accuracy of, you’re just gambling.  This is another reason to hire an appraiser up front – we specialize in recreating the true incomes and expenses of real estate and we support those estimates with real, factual data.  We do it every appraisal report we prepare, year after year.  Why invest real money on unreal financial statements?

Secret # 8 – Err on the Side of Conservative Investments

If you have investments in a particular property type, whatever you do, stick to it.  Go with what you know.  If you’re a newbie, buy conservative investments like apartment buildings, mixed-use buildings or residential homes.  There is enough risk in a down market buying commercial real estate… you’re only adding to it by buying something you have no experience in.  Stay far away from business real estate like golf courses, hotels, marinas, car washes and any other real estate where the owner wants “business value” as part of the total sale price.

Think of it like this.  If it were such a great investment and it was easy to manage or run, why in the world would it be for sale at the bottom of the market?

Secret # 9 – Always Do Your Homework

If I presented to you a barrel full of coins and asked you to reach in without looking, what would you get?  Would you get a silver dollar?  Now if I asked you to reach in and select 20 coins, you’d have no problem picking out the silver dollar, right?  You’d have all your visual faculties to help you.  So let me ask you this… why buy the first thing that you see?  How about the second or the third?  It is a rare day indeed that a newbie hits a home run the first time at anything.

Third party professionals are your eyes.  Take your time, learn about the market, the neighborhood, the property type and what it takes to get financing.  If you’re going to hold the thing for 10 or 20 years, why rush?  You can’t expect to get straight “A”s without doing your homework.

Good hunting!

John Simpson, MAI