In the last episode we learned what is a cap rate and what should you be looking for when you see a property on Loopnet.
Today we’re going to be learning the questions that I ask a seller’s real estate agent after I take a look at a property on Loopnet and think that this could be interesting. You don’t necessarily need to ask all these questions every single time, but it’s a good idea to go over most of them when you call the seller’s real estate agent. Here it goes.
- The first thing you want to do is to introduce yourself and explain that you are a real estate investor. This way the real estate agent knows who they’re dealing with and can answer your questions appropriately.
- How long has the property been on the market? The reason you’re asking this is for you to understand if it has been on the market for a while, or if there has been any offers on the property, and if yes, why didn’t the purchase go through. Here you’ll want to understand why are people not buying this property, or if there were any offers, why did the purchase not go through. This way you can determine if the problems from the previous buyer is going to be a problem for you, and you can decide if you want to deal with that or not.
- What is the potential you see for this property from an investor’s perspective? The reason you’re asking this is to see what is in it for you as an investor. For example, when I call properties in California, sometimes they have a very low cap rate, so I really want to understand what is the reasoning behind this incredibly low cap rate, and why should an investor buy this property. A lot of times the real estate agent cannot answer this question! This is very important because if there’s no meat in the bone, AND the market is incredibly hot, you don’t want to get yourself in trouble by paying a very large price for a property that is already charging top rent (and you won’t get much upside when the leases are over), so you really want to be careful here. The things you’re going to be looking for as an answer will be “This property has been at a 95% occupancy rate and right now it’s at 90% so you have another 5% that you could add to the property”, or “There’s an upside in rent if you could paint the property and do some remodeling in order to increase the rent”, or “It’s in a great corner location and you can actually put a couple of billboards up and get some additional income”. So there are all kinds of answers you’re going to be looking for.
- Are you local? You’re just going to ask them this question if you don’t think that the real estate agent is local to the property’s location. The reason behind it is, you want to know if they can talk about the area, do they really understand what’s going on in that area, is there really an upside for that area of the city or town, etc.
- How did you come up with the price? Here you’re also going to get all kinds of answers, sometimes people do get offended with this question – maybe because it’s overpriced! And when a real estate agent cannot explain how they priced the property, to me it means that it is overpriced, and to me, they’re just expecting a foreign investor who doesn’t know much about the market to buy it without asking a lot of questions. A good answer to this question on the other hand is “we’ve taken a look at five other properties that have recently sold in this area and that’s the price that is going per square footage” or “we’re basing this price on a cap rate of 5% because we have Burger King as a tenant” all of which are legit answers, as long as there has been some work that has been done in order to come up with this price. A lot of times real estate agents will go a little bit deeper and explain that “properties here sold for $170/sf and we’re actually listing this one for $150/sf, and it’s also a corner unit which is a whole lot better than the one that sold for $170/sf.”
- Who is the seller and how long have they owned the property? Here you want to understand if they’re just “flipping the property” or if they’ve been in it for the long run, or if they’re going through a 1031 exchange (and I’ll explain what a 1031 exchange is at a later time), but what what you need to know on a 1031 exchange is, the seller has to sell the property relatively fast, and this could potentially give you some leverage in negotiating the price when you’re putting down the offer. Other things that you want to look for, especially if you’re buying in an economic downturn is if there has been a death in the family, because the family has to sell in order to pay inheritance taxes – and these taxes are due really fast since the government doesn’t wait around! When we are in a down economy, and the seller needs to sell, there’s definitely a huge room for negotiation and I have heard of properties that were listed during the downturn for an incredibly low price and ended up being sold at half that price because the family simply had to sell – this is when you can get the deal of a lifetime that is going to set you up for life.
- Is there any known contamination in the property? The reason you’re asking this is you really don’t want to be spending thousands and thousands of dollars removing contamination. Whether they know if there is contamination or not, you’re going to have to end up doing what they call a “Phase 1 environmental report” and sometimes the seller does that in advance when the property is incredibly expensive, however, for the most part you’re the one who’s going to have to order the environmental report. This report tells you if there is any contamination on the ground or not. If there is contamination on the ground, it’s going to cost you a lot of money to remove it and you probably don’t want to be dealing with that. A couple of other things for you to know here is if the property is next to a gas station, or if it’s next to a dry cleaner, it is probably contaminated. However if it’s next to a big corporation such as Chevron or Texaco, they will take care of it, but if it’s a small mom-and-pop gas station you are unlikely going to get the the property decontaminated by them.
- Does anyone have the right of first refusal (aka ROFR)? This means that when you are buying a center with a big tenant such as Walmart, Walmart could potentially have on their lease a right-of-first-refusal – this means that once you submit an offer to buy the property, Walmart is going to say either “Yes, I want to buy this property for the price that this person is offering” or “No, I don’t want to buy this property for the price that this person is offering”. What does this imply to you is that when you are submitting an offer for something like that, you’re going to be spending a few thousand dollars writing the offer with your attorney, and of course we’re talking about more sophisticated investors, when you’re buying a smaller center you’re probably not going to have to deal with this price tag – but it’s good to know and it’s good to always ask.
- Are there any easement agreements? What’s an easement agreement? It’s when you let someone else use your property without giving up your ownership. For example, when you have a farm and you want to let someone drive through your farm on a road in order for them to get to their farm. It can also happen in a strip center when the center has been divided into three parcels and the original owner sold each parcel separately. You now all share the parking spaces and parking area. It can also mean that the city could potentially have a road through your property and they are able to use it at their own will. You really want to make sure that you understand if there is an easement agreement on the property, because one of the consequences is that you’re probably going to have to pay for the maintenance of that road while other people use your property.
- Please send me the rent roll. Sometimes they’re going to ask you to sign an NDA before sending you the rent roll, but for the most part you’re not going to have to sign one. When you get the rent roll, you’ll have to take a look at the following: how much they’re charging each tenant per square foot, when were the last few leases signed (and at what price), has the price of rent gone up or down, etc. I recently came across a property for sale that I initially thought was very interesting, it was around 80% full and they had recently emailed me saying that they just signed new tenants, bringing the cap rate from 7.5% to 8%, however, this new lease was for $1/sf/month, when they were previously leasing it for $1.50/sf/month, and I had to find out why they lowering the rent per square foot and why did they lock someone in at that low price – you really need to study the rent row. I have missed this many times and my dear mentor has had a lot of patience with me and brought it to my attention “look at the rent row, look at what they were charging in rent before, and look at what they’re charging right now, look at all the leases that are going to expire in 3 years, and there are quite a few of them – and in three years we could very well be in a very bad economic downturn – do you really want to have a vacant property when things are not doing that well?”
- Is the building historical? In many downtown areas there are several historical buildings, and the reason you need to know this is because you cannot tear it down you cannot do much on that property, and a lot of times you cannot change the usage on the property either.
- Has the building been retrofitted (if older building)? Do you have any estimates to retrofit the building if it hasn’t been retrofitted yet? Some cities have made it mandatory to retrofit buildings. For example, after a couple of earthquakes happened in San Francisco, the city made it mandatory for several buildings to be retrofitted so the risk of the building collapsing decreases during the next earthquake. What does retrofitting mean? It means that you have to reinforce the first story of the building because it’s substantially weaker and more flexible than the stories above. It it is very weak because there are not a lot of walls or frames on the first floor, so what you have to do when you need to retrofit a building is you have to hire a structural engineer or an architect that specializes in retrofitting, plus you need to spend anywhere from $60k-$130k and that can take a while to get finished. Not only that, the city of San Francisco will charge you a percentage of your work construction costs as a fee when you apply to get the permit to retrofit your building! Oh and one more thing! If you have a multi-family property in San Francisco, and your tenants lose their parking spaces during the retrofit, you will have to take care of that yourself!
These questions have been my go-to questions when I call a seller’s real estate agents, if you forget to ask a couple of questions it’s not a problem, you can just call them later or send them an email asking the questions you forgot to ask! In the next episode we’ll be going over my first offer experience and what happened with that first deal.
“Most of the successful people I’ve known are the ones who do more listening than talking.” ― Bernard M. Baruch