Discover how to buy distressed commercial real estate for BIG returns! In this video you'll learn how my protege, Chet, seized the opportunity to purchase a distressed commercial asset for $3.25MM, overcame tremendous challenges, and is turning it around to create a stable, cash flowing property worth over $7 million!
My protege, Chet, has had a successful career working in the pharmaceutical industry for 19 years. However, he had a powerful motivator to join my Protégé Program and become a commercial real estate investor. Chet grew up in a large family, and even though both parents worked, they always seemed to be short on cash. He wanted his own family to have the freedom to do all the things they enjoy without financial stressors. His goal was to give his family the financial freedom he never had and allow them to bear the fruits of what commercial real estate provides. That’s what motivated him to do BIG deals. We saw a diamond in the rough in this big distressed deal, we persisted to put the deal together and struck gold in securing this off-market deal!
Disclaimer: Purchasing distressed commercial real estate involves considerable risk. It's important as a beginner investor to have a mentor or coach to guide you through it. It's also not for the timid; you need guts to take down a deal like this, which Chet did with our help. There is potential for BIG returns, but to get them you need good timing and experience.
Distressed Commercial Property Case Study - Upstate New York
Property: 68-unit, two-bedroom apartment building
Purchase Price: $3.25 million
Physically Distressed Property: The seller was managing the property himself and didn’t have the time to properly manage this asset. Over 20 years the property became too much for him and in the last five years, it became distressed from deferred maintenance. Rents were under market and the property needed $250,000 in renovations.
Financially Distressed Seller: The sellers were extremely cash strapped because of New York state’s eviction moratorium. The moratorium significantly affected the owner's ability to collect rent over roughly two years. There were a lot of new cars and boats in the parking lot, but hardly anyone was paying rent. As a result, the seller was hemorrhaging funds and just wanted to walk away from the asset.
Occupancy Rate: It's important to differentiate between physical vacancy and the economic vacancy. The property had a 10% physical vacancy, but because tenants weren't leaving or being evicted based on the moratorium, 75% of the tenants were not paying rents. Out of the 68 units, 10 units were paying some portion of their rent, but they were in arrears as well.
Creative Financing for Distressed Commercial Real Estate
Financing the Deal: Chet put together a plan detailing what the ARV would be for the property once it was stabilized, cash flowing and NOI was where it needed to be. With that portfolio in hand, he went to several different banks. Of course, based on the asset in it’s current condition, a lot of them turned him down. Some of them considered bridge loans but based on the financials and the financials of the ARV, Chet landed on a bank that provided a line of credit for 75% of the $3.25 million asking price, leaving a 25% down payment.
The line of credit is good for two years, and none of the renovation money was utilized upfront. Instead Chet used seller financing. He enticed the seller to finance by offering him a chance to get some of his money back that he had lost during the moratorium. The seller agreed to $250,000 at 5% interest and Chet utilized those funds for the renovations right out of the gate. He will use some of the line of credit for renovations down the road as they are needed.
Stabilizing the Property
Turn Around Plan: Together with his property manager, Chet has come up with a plan to stabilize the property and create a productive, cash flowing asset. The turn around plan for the property is to increase the rents to market value. Now that the moratorium is over, they plan to give the tenants who are in arrears the opportunity to catch up, in addition to paying the current rent. They must sign a new lease agreeing to pay the arrears in three months, as well as the increased rent. Those who can’t meet those demands must vacate the premises. So rather than just evict everybody, they will give them a chance to pay and recover.
As tenants leave, management will refurbish the units with new paint, new flooring, and minor repairs. They will increase the rents to market value and then rent out to a new tenant. The exterior of the property needs some landscaping and cosmetic upgrades to improve curb appeal. The interior of the units are for the most part adequate and only require cosmetic upgrades. Other than some deferred maintenance issues, this property was more financially distressed than physically distressed.
Rent Upside: The rents ranged between $650 and $750, and will be increased to $895 and $950, which is market value.
After Repair Value: $7.34 million.
Exit Strategy: Chet plans to do a cash out refinance in the next four to five months. That cash out refi will allow him to grab the cash from the equity and then pay off the line of credit, refinance into a long term, low interest rate, 30-year loan, and then pay back the seller’s $250K. He will then hold the asset long-term for cashflow. Once the new loan is in place, the asset is projected to cashflow between $400,000 and $500,000 each year.
There were two major challenges to securing this deal. The most difficult part was dealing with the state of New York and their moratorium relative to COVID 19. The eviction moratorium allowed tenants to essentially live rent free at the owner's behest. So how to solve that problem was a big hurdle to overcome.
The second challenge was the span of time to secure the asset. Chet had a contract in place with the seller, but it took a long time to exercise on that contract. With all the due diligence, they couldn't get inspectors into the buildings with tenants because of COVID restrictions.
The state's pandemic regulations were the difficult part of securing the deal. But for Chet, it was without a doubt worth the risk. He says, “Like most things in life, if you stick to your guns and you see the fruits of your labor, it's worth the risk”. He plans to continue searching for deals in commercial real estate and is looking to become a full-time commercial real estate investor in the near future. Although he enjoys working in the pharmaceutical industry, he believes a path toward full-time commercial real estate will achieve his goals.
What Does it Take to Buy Distressed Commercial Real Estate?
- Be Patient: It took a long time to close this deal, but Chet had the mindset needed to persevere. Was it worth it to create four million dollars for his family? Absolutely. Be patient and stay diligent.
- Utilize all Resources to Find and Secure the Deal: Chet took full advantage of our Protege Program and the marketing tactics we teach. We also help our students create relationships and connect with resources. Chet's lender was one of our lenders and they worked together to creatively finance this distressed asset for BIG returns.
- Stay Humble: Your dreams will come true if you stay humble, have a focus, and have a vision. Commercial real estate is something that everybody can do if they educate themselves first, and if they stay humble and keep their eye on the prize.
Buying distressed commercial real estate requires three things: good timing, practice, and guts.
Did Chet have good timing? Yes, he did. Think of timing as opportunities. As Thomas Edison said, “Opportunity is missed by many people because it is disguised as overalls and looks a whole lot like work.” Many people would pass on this deal because it was disguised as overalls and work, but Chet didn’t. His timing was perfect.
Did he have practice financing and turning around a distressed 68-unit apartment building? No, he didn't, but he had Commercial Property Advisors to walk him through it. We have the real-world experience needed to execute a deal like this.
Did Chet have the guts? Absolutely. If he had said, "Peter, this is too much for me. I don't want to do it.” By all means, let's cancel it. We'll never force any deal on any of our students. But Chet had the guts to pursue this one and it is a life changing deal with BIG returns!
Must Watch! My teaching called How to Buy Distressed Commercial Real Estate is a must watch for those who want to learn more on how to invest in distressed commercial real estate.