The one good thing about traveling is we get the chance to catch up on my news reading. While waiting for our flight to Cleveland we found an article in the Jan 2 edition of the LA Times titled 'Investors see commercial real estate as a good bet'. Since we couldn't agree more we read on.

A couple of key quotes had us nodding in agreement: 'Commercial real estate continues to offer attractive yields compared with alternative investment vehicles, said respondents to a quarterly poll by consulting firm PricewaterhouseCoopers.' and '"Investors continue to view the apartment sector as an attractive play in delivering steady cash flows driven by solid rental demand and rising rents," said Susan Smith, editor in chief of PwC's survey. "As a result, investors view this sector as a hotbed for further investment activity."'

There are a lot of distressed commercial properties in really good rental markets. Most of the questions we get from others interested in investing is 'If these are such good properties, why are they distressed and heading for foreclosure?' Great question with an easy answer. Most of the distressed properties we have looked at are the result of the owner buying close to the peak of the market with a highly leveraged property, and then their 5 year renewal comes up and the bank won't renew because the property value is less than the mortgaged value, and no one else will touch it either. It's sad to see as most of these owners have never missed a payment and the properties are cash flowing just fine.

The really stupid part of all this is the way banks deal with the property. The first thing they do is kick everyone out and board up the building. The properties usually end up staying vacant for some time as the mountain of bureaucratic red tape at the banks cause everything to grind to a crawl. In the meantime the buildings get vandalized and decrease in value at a staggering pace. Only a bank can take a cash-flowing asset and turn it into a hole in their books in relatively short order. Makes you wonder how these guys stay in business sometimes. Hold on, right, a bunch of them went out of business.

Enter the commercial property investor. Let's take our Cleveland property as an example. The owner of the property has an ~$850,000 mortgage on a property that was bought just before the peak. 4 years in he realizes the property is now worth less than the mortgage value and the bank will not renew at term. What does he do? He stops paying the mortgage, keeps all the rent until the bank finally forecloses on the property. The owner walks away and the bank is left holding the bag for $850,000. First thing they do is kick out all the tenants, board up the property and it then sits for about 18 months. The foreclosure process completes while the property is vandalized and pillaged for anything valuable. The bank finally tried to unload the property and takes a huge hit and has to unload it for $150,000, less outstanding taxes and a water bill. In we come, rehab the property for ~$250,000, and will have a commercial rental property valued at about $1,000,000 that cash-flows at a conservative $125,000 per year (NOI) at a Cap Rate of about 31. Outstanding! Now we hold on to the property for about 18 months and refinance to get out $400,000 investment back out to reinvest elsewhere and enjoy the healty NOI.

We'll be looking for more deals like this one while we're in Cleveland. We have investors who are happy with 10 cap properties that require no rehab, and others that like higher cap rates and don't mind the rehab process. We'reI'm on the hunt for both.

Until next time - Happy Investing!


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