Rental Property Investing - "Non-Performing Properties"

Is buying a ‘Non-Performing Property’ (NPP) as an investment a good idea?  Well that depends on a couple of key factors – primarily what type of re-development plan for the property do you envision – and how do you plan on financing it in the interim? Suffice it to say, this type of investment is higher risk, but potentially with a higher reward/upside.  

Consider the following examples:

·            Plaza with 50% vacancy

·            Vacant Commercial Building

·            Distressed Property Requiring Extensive Rehabilitation

·            Commercial/Industrial Land Site

·            Institution Lands (previous school or church)

·            Bank Sale (Foreclosure/Power of Sale)

In all of these cases, there is either no cash flow, or less than there should be.  Cost to carry properties is a serious consideration, and you need to factor it in for a period of transition – say 6 months to renovate a building for a new user.  In the case of a multi-unit development, you may also face a further holding period - assuming it takes another 6-12 months to find the right tenancies.  Cost to carry is a major part of your Due Diligence, in analyzing NPP opportunities.

If you are owner-occupant/user, looking at this type of real estate may make a lot of sense, given the value they can offer.  Re-purposing of NPP over the past few years, has been a popular theme in challenged markets across Canada.  By definition, this type of property continues to lose money daily for the current owner (Seller), and the Buyer leverage should only be strengthened in any purchase negotiation.

In every market, there are investors who make their living in this category and do so successfully. Take the time to not only examine these properties, but the background  of what was required to make them viable investments.

As always, seek out experienced commercial realtors within your market to assist in reviewing potential NPP investments.  For an example of a current NPP we have listed, please click here.

Rental Property Investing - "Special Purpose Properties"

Is buying a ‘Special Purpose Property’ (SPP) as an investment a good idea.  If the cash flow is sound based on a long term lease, and it generates a good return, as an investment property, this might be the right move. But then again…maybe not.

Let’s first look at what a SPP is defined as – “a limited market property with unique design characteristics that may have been built with specialized construction materials or offers a layout that restricts its utility to the use for which it was originally built”. They often have limited conversion potential as built, without having to incur substantial retro-fit costs.  

Good examples of this type of property might include:

·        Bowling Alley

·        Church

·        Car Wash

·        Daycare (particularly larger centers)

·        Nursing Homes/Elderly Care Facilities

·        Marinas

·        Theaters

Basically – they are what they are. Should the use come to an end at some future point, can the building be re-purposed and at what cost?  For the investor, when the use ends, what are the implications regarding the lease and future cashflow. On the concept of re-purposing, in reality it is very much dependent on the calibre of the marketplace you are in and its future economic outlook.  It’s a clear risk and you do need to account for it, as a major part of your Due Diligence.

On a final note, lenders have their own criteria relative to the category of SPP, and best practice is to get their perspective on what sort terms are available, before proceeding on such an investment. Suffice it to say that the Tenant’s Covenant will be crucial to the Lender – as it should be to you.

As always, seek out experienced commercial realtors within your market to assist in reviewing potential SPP investments.

Rental Property Investing - Medical Properties

An attractive sub-group within the office category, are medical office properties.  Medical office properties can involve ‘single user’ formats, as well as ‘multi-tenant’ developments.  Multi-tenant properties are able to bring a variety of medical practioners under one roof, as well as offer various related services - such as pharmacy, laboratory/diagosotic, and physio/chiropractic, to name a few.  Locationally, they can be in established or growing residential neighbourhoods, busy commercial areas, or near primary care hospitals in a city.

Medical office properties have typically been characterized as being stable from both a tenancy and cash-flow perspective. Physicians do not generally move around, and at minimum can stay in one location for 5-10+ years.  Lease rates on comparable buildings, would likely fall in a narrower and more predictable range within any given market.

All of the same discussion points in evaluating retail and office properties would apply here. Economic performance would consider applicable cap rates for other medical property sales in the area, as well as a diligent review of the tenant summary to assess its overall stability.

Being a landlord of a medical office property presents some different challenges than you might see with other commercial centres. Firstly, parking availability is critical for medical users, and often commands a much higher ratio per square foot, in comparision with retail or business office uses.  A busy medical specialist occupying 1500’, can utilitze 15-20 parking spaces during his normal office hours.  This may be 3-4 times the need of a business office use (ie. insurance office).  Pay particular attention to the area of parking, because it must be adequate for all tenants and their patients/clients.  Best practice here, is to observe the site at busy times and get a good sense of how it functions on a daily basis. In addition, pay close attention to the standards of accessibility for elderly/handicapped, sound proofing needs, and restrictive convenants which preclude competing uses.

The best medical office buyers should be ‘physician-owners’, who are likely setting up practices for the long haul and would effectively pay the building off over a 10-20 year stay.  In today’s market, traditional real estate investors/landlords are drawn to well-tenanted medical properties across North America – and why wouldn’t they be?  With aging populations, health care spending on the rise, and the field of medicine expanding continually, it would seem to be a ‘sweet spot’ for real estate investment.

   

As always, seek out experienced commercial realtors within your market to assist in finding suitable Medical Property investments.

Rental Property Investing - Office Properties

Now let’s look at Office properties. Again, they come in many shapes, sizes, design styles, and for a variety of user types. Specifically on users, they can be categorized as follows: business office, institutional/government, medical or commercial service.

Multi-tenant office developments may be located near residential neighbourhoods, within business parks, or in established commercial districts within a city.  Tenant rosters could include accounting firms, law offices, personnel agencies, mortgage brokers, insurance offices, and chiropractors.  As in the case of retail, a development can be designed for a single user and within a freestanding building.    

In looking at successful office properties – same advice as with retail -- pay particular attention to not only the property’s current vacancy status, but what its historical pattern has been. Are current rentals on a per ft. basis, at or above/below the prevailing office rates within the area. It’s all about supply & demand, and lease rates are mostly dependent based on the realities of your particular marketplace.

As with other commercial properties, the value of an office building is very much tied to the amount of rent collected. Review applicable Cap Rates for recent office building sales, to give you a benchmark as to how your subject building relates. Also in studying the tenant summary, how dependent is the landlord on 1 or 2 units in order to sustain an adequate cashflow?  It’s the ‘What-If’ analysis – so if a tenant occupies 50% of your building (representing 50% of your rental income), what happens when they leave and how easily can the unit be re-tenanted and at what cost?  It is as we’ve said many times before, all about good Due Diligence.

Just a final word, on evaluating a property to see how it performs on a daily basis.  Visit the site during busy times and see how it functions – Is there really enough parking?  Is there a good/compatible tenant mix? Ease in visitors accessing the site?  Does it appear to be an operational success for tenants, their employees and visitors?  On site observations are always well worth the effort and can tell you a lot about the viability of the property.

As always, seek out experienced commercial realtors within your market to assist in reviewing viable Office Properties as investments.

Rental Property Investing - Retail Properties

Another decision you must make when considering rental properties -- what type of property to do you look to invest in?  Based on the market you’re considering, are retail centers preferred or do you see office uses as being more optimal?  Let’s first look at Retail.

Retail properties come in many shapes and sizes.  Think neighbourhood plazas which might include a fast food restaurant, laundromat/dry cleaner, variety store, beauty salon, etc.  These are viewed as convenience centres and for the most part, serve the immediate neighbourhood. The same can be said for freestanding buildings (serving a single tenant), but again, target the neighbourhood demographic as their primary customer.   

In looking at successful retail opportunities, pay particular attention to not only the property’s current vacancy status, but what its historical pattern has been.  In addition, you want to look at the availability of parking, neighbouring tenant mix, and the tenure of current occupants.  Bottom line – is it a quality development which results in successful and stable retail operations?     

In addition, you should examine general vacancy trends in your market.  Stronger lease rates typically go with higher occupancies and vice versa.  It’s again a due diligence exercise – but the data/information is out there and you need to make best efforts to obtain it.  Stay where the action is and look where retail tenants succeed.

As a final note, with respect to financing retail properties, certain lenders may prefer this area of real estate versus other categories (ie. office or industrial).  Keep this in mind as you consider financing options. 

As always, seek out experienced commercial realtors within your market to assist in reviewing viable Retail Property Investments. 

Rental Property Investing - Single Tenant vs. Multi-Tenant

This is a debate that has gone on for years – do you opt for a Single Tenant property or do you consider only Multi-Tenant buildings.  Lots to consider here, and as with everything in real estate investing, ONE SIZE DOES NOT FIT ALL!

Look back at your objectives and confirm what you are trying to achieve.  Is it ROI? Is it minimal management? Best opportunity for price appreciation?  Risk tolerance? Income growth through lease rate expansion? Mid-long term lease commitments? Triple A Covenants Only?  These may be some of the key criteria which you have identified.

Now let’s look at which Property Type, each of the above tends to favour.

ROI                        -  Multi-Tenant more likely

Price Appreciation   -  Multi-Tenant more likely

Management           -  Single Tenant less management (if any)

Risk                       -  Multi-Tenant more likely (spread across multiple leases)

Income Growth        -  Multi-Tenant more likely (given multiple leases)

Long Term Leases   -  Single Tenant more likely

Triple A Covenant     -  Single Tenant more likely

You can see the benefits of each, given the criteria that we’ve set out – but it all comes down to what you are prioritizing. There are clearly advantages to both and again as we’ve said many times, it is a set of property objectives that must be aligned with your particular market. For those of you keeping score, the above comes out 4-3, in favour of Multi-Tenant investments.

As always, seek out experienced commercial realtors within your market to assist in reviewing the available Single Tenant vs. Multi-Tenant opportunities.

Rental Property Investing - Debt Coverage Ratios (DCR)

Since leverage involves debt, let’s discuss how we analyze the debt relative to the property’s cash flow. The standard measurement within the investing world, is referred to as the Debt Coverage Ratio (DCR). The math is pretty straightforward –the ratio measures the property’s net cash flow divided by the annual mortgage costs.

Consider the following examples:

Property 1                                                   Property 2

Net Operating Income - $75,000                Net Operating Income - $45,000

Mortgage Costs (Debt) –$50,000               Mortgage Costs (Debt) - $50,000

DCR – 1.5                                               DCR – 0.9

• All Dollar Amounts are annual

Now in the case of Property 1, the cash flow comfortably covers the mortgage requirement with a residual leftover (AKA –return on cash invested). With Property 2, a deficit is created (of $5000), which in essence becomes an annual loss and generates a negative return on your cash invested.

The significance of this exercise becomes really clear once you look to arrange mortgage financing in either case. The 1.5 DCR will receive good support with the Commercial Mortgage lenders, as the cash flow of the property provides a cushion against the mortgaging costs you will be incurring. However in the case of the 0.9 DCR, the deficit will raise red flags with Commercial Mortgage lenders and certainly fall outside of their normal guidelines.

Standards will vary from area to area and lender to lender, in terms of DCR ratios required. But more importantly, it must fit with your own objectives for investing and in considering viable rental property options.

Again, seek out experienced commercial realtors within your market to assist in searching out rental properties with positive DCR(s).