In the last post, we learned about what types of real estate investments you can make on the residential side, as well as the commercial side. We also learned why I decided to invest in commercial properties instead of residential properties. In this post I’ll go over my very first offer (which happened about 4 months into my real estate education). I have to break it down into a few episodes because it’s going to be a detailed explanation from beginning to end, and it will be as follows:
- How did we decide to make an offer on this property
- What did we ask the real estate agent to send us during the due diligence process
- Are we running this as a business or selling after remodeling, plus all the financial calculations
- Which items our attorney looked at and objected to from the title report
- What ended up happening and conclusion
How do I decide if this is a potential property I want to end up buying or not is as follows:
I keep track of all the properties that I find interesting on Loopnet and Crexi, I then call all of the seller’s real estate agents and I ask them the questions that we covered in our last episode. If I find that these properties could have potential, I send them to my mentor, along with the answers that the real estate agents gave me. My mentor then tells me yes / no / let’s find out more. I then call the real estate agents again to get the additional information needed. On average, out of 10 properties that I reach out to, I follow up again on 2 of them to ask additional questions.
This property was one of these 10, and he quickly said that he really liked it, and for us to take a look at it that weekend. The property was an old movie theater in the city of Salinas, CA, which is considered the salad bowl of America – this is where a lot of our vegetables are grown. It’s also a city that is very close to Carmel Valley which is a beautiful area and very expensive. Salinas is about 20 minutes from Carmel, and they get a nice breeze from the ocean, so the weather is quite nice. The price was $500,000, around $83/sf. The theater was abandoned for the last 30 years, and nobody had been using the property or keeping up with code for 30 years and it was literally falling apart. That’s why the price was about one-third of the price that other properties were selling for in that area (on the low end). It was in a very cute downtown area which I personally like, and I think that of all retail real estate, cute downtown areas are the ones that will definitely survive, so we could potentially turn his property around and make a good amount of money in a short period of time.
We took a look at the property, and the first thing that you notice is that a lot of movie theaters have two little stores on the sides (to the left and right of the main entrance), they were probably ticketing booths back in the day, but nowadays the movie theaters have an actual tenant on both sides, and these little stores are pretty small at ~500 to 700 sf each. On this property, one of them was actually rented out to a nail salon that had been there for a while, and they were on a month-to-month lease paying below-market rent. The other side was remodeled and vacant, and the inside of the movie theater had not been touched for 30 years, so you can imagine that things were really falling apart. However, as soon as you walk in, you can tell that if this building was remodeled it would be such a beautiful property and you just start wondering what you could do with it: one option was to remodel the bare minimum, bring it up to code (i.e. the bathrooms had to be ADA compliant, install fire sprinklers, install a new roof, etc) and sell it right away. Another option was to remodel it to the maximum and bring the property to the best shape it could be, and then rent it out to parties, events, corporate gatherings, etc, here we could potentially run the business ourselves or partner up with someone who would run that business with us. And lastly, we could remodel, bring a very good tenant and give them some TI (tenant improvement) money to bring the place up to what they needed. Note that if you can bring a national tenant, you typically have to give them a lot of money for TI, but if it’s a small mom and pop tenant, you don’t need to give a lot of TI money.
With these three options in mind, we decided to put an offer and then figure out what we could do with it as we went through the due diligence process. If the numbers didn’t make sense, we could always withdraw our offer and just end up paying for the inspections. We made an offer of $430,000 and decided to use the seller’s real estate agent as our agent because we found the properties ourselves, and it would be easier to work with one real estate agent. The seller ended up accepting our offer, but they didn’t want to pay for the inspections (this request was part of our offer, because if we didn’t end up buying it, we didn’t want to have to pay for it). However, we just let it go since they accepted our price.
Things to note on the offer agreement
We used the standard commercial offer agreement, and as noted above, we had to give the seller all of the inspections if we didn’t end up buying the property, so they could give them to the next buyer. A few other things that I highlighted on the purchase agreement were: 1. We needed to deliver the removal of contingencies or cancel the agreement within those 45 days, 2. If there was any problem with his purchase, we would have to resolve it through arbitration, 3. Both buyer and seller pay for escrow fees, the seller pays for County transfer fees, the seller pays for the city transfer fee, the buyer pays for all the reports, and the buyer also pays for the title insurance policy. These are just standard terms and we agreed to them.
I then went to the title company and got the escrow opened, I gave her the $15,000 refundable deposit and then I went to see the property again – this time I took pictures and I recorded videos of the property – it was one of my mistakes and I should have recorded the very first time we were there. When you go take a look at a property there are many things going on, and we can easily forget them, so make sure to take pictures and videos on the very first time you go there. Also, if you can, bring someone with you – there was a lot of information that the real estate agent was giving us while we were touring the property and some of that information I remembered and some I forgot, some information he missed and some of it he also remembered, so together we remembered a lot more than we would have if we had gone alone. For example, the real estate agent said that quite a few people had been contacting her and were interested in renting out the small area next to the nail salon, and she said that she would give all that information from these people to us once we completed the purchase – I never remembered her saying that, but my mentor did so I took notes so that I wouldn’t forget to ask her once the escrow was closed.
Here are the things that I asked the real estate agent to send me during the due diligence process:
1. Recommendations for Structural Engineers, roof inspector, and contacts in the city of Salinas since she had been a broker there for a very long time, and she knew quite a few people.
2. The last structural report done on the property.
3. The blueprints so we can give them to our architect, otherwise if the architect did not have the blueprints we would have to pay around $10,000 to get have them redone. I needed those blueprints not only in paper format, but also in digital format since I wanted to forward it to our architect digitally via email. Both of these cost money so since she had the original blueprint (and it was about 11 pages long) she had to scan the blueprints and send them to me.
4. Rent comps, and sales comps in the area. Both of these are important in order for us to understand what we could rent the property for (and therefore what we could sell the property for), and what were people paying in that area once the property was fully leased and fully remodeled. All of this information was used in my financial analysis to do a best and worst case scenario so we could see what was going to be an ideal price for this property. Note that I asked for leased comps and sales comps from two different real estate agents and both of them provided me different numbers so I had to average them out to come up with the final number. You really want to make sure that you ask for comps from more than one real estate agent.
5. The lease for the nail salon, they were on a month-to-month lease and I wanted to understand if they were below market or not. It’s also important for us to have a copy of that.
6. Who the owner of the building next door was, because we were sharing a wall with them and we needed to understand if they did anything to the wall or not.
In Part 2, we’re going to go over how we approached our decision regarding what we were going to do with the movie theater: are we going to remodel it and run it as a business ourselves, are we going to remodel the very basics and just sell the property, or are we doing some remodeling, bringing a very good tenant and giving them some TI. I’ll also go over the financial calculations that we did, what did our attorney ended up objecting to on the title report, what was our final decision, and how much did we end up spending on this property.
It has to start somewhere, it has to start sometime, what better place than here? What better time than now?
Zack de la Rocha