Real Deal REInvestor Network

For me nothing is a competition anymore, it's about doing the best that I can do without being distracted by whether or not someone else is doing better. I should be chosen because I bring the perfect mix of passion, experience and a desire and willingness to learn. I've already learned a lot in real estate, but my head is not too big to realize that I do not know it all, especially because there is constant change, it's an ongoing process. I relish the opportunity to  work with other hungry entrepreneurs who love to play the game as much as I do. My own business has been all about giving back to the community and from what I understand about this MMM, we appear to share this ideal. It staggers my mind to think of how much money we can generate together, how much good we can do, and how much fun we can have.  

Financing the Property    
This 70% loan loan-to to-value deal should be very easy to finance. For one thing, one of the signers on the loan has owned the property for 15 years and has a great payment record.
To make the cash flow work, start with the Gross Operating Income of $720,000. Then subtract the annual debt, which is the mortgage payment: $4.2 million x 7% for 25 years x 12 = $356,260. NOI is $500,000, which you divide by $356,260 for a total of 1.4 Debt Coverage Ratio.
The Debt Coverage Ratio indicates what kind of a cushion the borrower has in the deal. If you have an NOl of $500,000 and you’re only paying $350,000 in debt service, you have about a 40% cushion. Most banks want 1.2 ratio, but you’re giving them 1 .4 ratio.
Their conforming loans are between 75 and 80%. Since you’re giving them a 70% loan-to-value, the bank should agree to the loan without question. After you’re finished paying on this loan, you’ll have $143,000 in cash, half of which is yours.
As to the owner, he dramatically reduced the amount of his cash flow but he still has that $1.7 million in his hand, and if the property was resold 10 years from now, it is likely to bring $10 million to $12 million.
LLC Partnership
One of the best features of an LLC, and why it’s so popular today, is that you can structure create an LLC within an LLC, which is an IRS-recognized structure. It’s usually recognized in any state you’re in as a type of a corporation, but the IRS recognizes it as a partnership, which is why you can make contributions to it that are not taxable.
Another feature of an LLC is that you and your partners can reallocate the benefits periodically.
You can set this up in the very beginning or by unanimous consent. As you go along, you can change the benefits, one to the other.
Changing the Deal
Consider the scenario where the owner changes his mind and decides that he’s not going to give you half the cash flow in this deal, which amounts to $143,000 in cash.
You can make an agreement with him wherein he acquires half the stock, and until he’s gotten back the $1.7 million left in the deal, ‘you’ll only take a quarter of the income. So, it will take about 17 years before you get anything more than 25% of the cash flow, but you still own half the property.
Therefore, if five years from now, you sell the property for $9,000,000, he the owner will get back his $1,700,000.  first on that 75-25 basis. The remainder will be split 50-50.
So, don’t consider it an obstacle if he insists on having a bigger portion of the deal. If you get a quarter of the income now, you can equalize the deal when the property is sold.
First-Out Situations
First, he will get his $1.7 million back. Next, you’ll count all the payments he’s received so far and subtract that from the $1 .7 million. Then if he’s already gotten back $200,000 in dividends, you only owe him $1 .5 million on this 75-25 split.  Anything above this, you split 50-50.
Even if you have to take less of the cash flow, always make yourself a 50% partner in the deal, so that at the end, you get your half of the profit. Ultimately, he gets his original equity back and you split the “monopoly money.”
This is called a “First-Out” situation. Investors receive their money first and you obtain yours second. Most people are used to this type of accounting when financing commercial deals.
Tip: Income property doesn’t appreciate as fast as residential, which is part of the reason you can buy commercial property proportionately cheaper than you can buy houses.

Closing a Large Office Complex Deal- Part 2
The next step for the two of you is to go to the bank and sign off on the deal. Even though you have an LLC, you should sign personally because the bank already has the property as collateral and they are more interested in the cash flow. That’s two of the C’s— all that’s missing is the credit, but this property doesn’t have any, so what they want is the credit of the people who own it.
Even if your FICO of 500 they aren’t going to refuse this deal because you have a partner with $3,500,000 of equity in the deal, who is going to sign personally.
That is one less obstacle, because the bank is going to view this as a viable deal. Your partner has real equity in the property, so they can use that for his down payment and they don’t care where the money comes from—they don’t even mind that it comes out of the equity of this property, because it conforms to the laws of their auditors.
Getting the seller to be your partner is the best form of financing there is. The seller has a substantial amount of money, has had this business for some time, and has some real motivation to execute this deal. Therefore, he is a prime candidate for this type of arrangement.
The “You and Me LLC” will buy the property for $6 million. Then, the owner leaves and takes out a big chunk of cash, meaning $3.5 million, of which he contributes half to the You and Me LLC. Then, he takes $1,700,000 out of the deal in cash, but you still own half the property.
Your partner now has a safe, profitable investment with which he feels very comfortable—it’s a built-in reinvestment plan. One of his biggest benefits is tax-wise—he now has half the capital gains on which to pay taxes, had he sold the property without reinvesting.
If he took $3.5 million out of this property, he would have to invest that somehow. When people sell something, they may be very pleased that they took all of that money out. However, if it hadn’t occurred to them up to that point, they have to begin to worry about reinvesting issues. This approach gives this owner a chance to reinvest the money in his own property, one that he knows quite well.
The new deal has the Him and Me LLC paying $6 million for the property. You must give him $1,700,000 and pay off the $2.5 million mortgage, so you need $4.2 million to complete the transaction.
The $4.2 million you need to borrow is 70% of the total property value. With this figure in mind and your contract in your hand, you and the owner go to the bank together. Hand them your contract showing that the Him and Me Corporation just bought this building for $6 million. You have $1 .7 million for the down payment. Therefore, all you need is a 70% loan to value, since the building carries itself.

Closing a Large Office Complex Deal
Finally, you can add stability to the deal for the purpose of borrowing. For example, let’s say you are considering buying a large complex with four different buildings, all ground floor level.
Six units are in each office building, so that’s a total of 24 units. The person who is selling has had the property for 15 years.
Since he has owned it for this length of time, there’s probably plenty of equity in the property. Fifteen years ago in Fresno, California, he may have built a complex like that for $80 to $90 a square foot, including the land. Today it would take $200 to $300 per square foot range to construct the same building.
So, the passage of time has created a lot of “monopoly money” in this deal. These are condo-ized units of 1,500 feet each that usually rent for $2,500 a month.
To calculate the PRI, take 24 x $2,500 a month or $60,000 a month, which totals $720,000 a year. So, we will assume that after subtracting expenses, the NOI would be about $500,000.
Now, in Fresno most people are obtaining an 8% “Cap Rate” for a deal like this, so you can be sure that it’s priced at approximately $6 million. If he started out financing 100% of the deal 15 years ago and paid $90 for the land and buildings, he paid $3,240,000 for the property.
He probably financed it for between 7 and 8%. If he borrowed 100% of the costs and then refinanced it immediately thereafter, he would still be about $2,500,000 in debt.
If he is an older person, he probably is seriously motivated to execute this deal—that’s why it’s for sale. However, it’s not an ideal situation for you to be approaching him about it. People who don’t have their property for sale, normally haven’t put a price tag on it, so it could be out of your reach.
To start the deal negotiations, you offer to pay $6 million with an additional motivator—if the property appraises for $7 million, you’ll give him $7 million.
You want to make as many assurances as necessary to make him comfortable with this deal, but you’ll need help to do this properly. That help is going to solve a few extensive problems that he might have when officially listing the property for sale.
What you’ll eventually want him to do is partner with you. However, do not offer that condition until you have a signed contract. Then, later that day or the next, arrange to meet with him again and mention that you thought you should have one more meeting with him before you start to raise funding.

You want to make sure that you have enough leverage and can use the bank’s money to make more money in this deal. Then propose the partner relationship to him. After all, he has to do something like reinvest this $3.5 million that he’s getting out of the deal.
Then you can suggest that he should leave approximately half his equity in this deal, about $1 .7 million, and you two can continue together as partners. You won’t need any other partners. You’ll take care of all the day-to-day activity and send a report to him in the mail every quarter, along with a good-sized dividend check.
Tip: Paying dividends quarterly is better, because it could be a fairly large amount of cash.

Measuring Office Space (BOMA)

Core Factor

The load factor is the rate at which you would have to load the usable to get to the rentable. That’s why they call it the load factor because it loads it up. However, it’s really just a fraction of that R/U factor. Experienced brokers call that the core factor.

You just don’t hear that much anymore, but when they ask you what your core factor is, that’s what they’re asking. When they talk about it being the core of the building, they’re referring to core elements like the corridors and bathrooms.

Efficiency

Efficiency is the reverse of the R/U factor. The only person who will ever tell you that number is your architect. He will just divide U (usable) by R (rentable) and, in this case, use the formula, 8500/9500, which rounds out to 0.9. The architect will say that’s the efficiency of the building.

Now, most buildings aren’t that efficient. They will have an R/U factor between 11 and 15, and the higher the RU factor, the less efficient the building. To keep from paying more for common elements, you might object and let the landlord know that you would rather go into a building that was more efficient.

A good tenant representation broker will point out to his clients that the real rent is based on the usable square footage and at least steer them towards the building that is more efficient. Most tenants will take the building that costs less and looks better. However, a lot of buildings that are less efficient seem to be a lot nicer.

The Class A office buildings with six-foot corridors, giant bathrooms, huge atriums, and big entrances must be much less efficient than smaller buildings that are built to maximize the number of square feet that you get tenants into.

Measuring Office Space (BOMA)

f you have one more tenant on that floor, for security reasons, you might need to build a hallway. Perhaps you’ll build two walls with one corridor because most cities will require you to have escape routes for people on upper floors. You have to be able to go to two different halls or two different fire stairs, and give them access to the elevators. As a consequence, if it’s a 5-foot wide corridor that’s 80 feet long, you just made 400 square feet nonexclusive or common area. Also, the single-user company probably has private bathrooms on the floor, which are under their exclusive use and control.

If you, as the landlord, put in two, 10 x 15 square foot bathrooms, his and hers, for the common use of both tenants, they will be paying for them, also. It didn’t matter before when there was only one tenant, but there are other common areas, such as an air-conditioning room (or a mechanical room) on this floor, and a janitor’s closet and a telephone room on the next floor, which is about 150 feet. So now, you have 150 plus 450 and another 400, totaling 1,000 feet of common area, including the hallway and the bathrooms and anything else. When you subtract the common area, you are left with 8,500 of usable square footage. What goes in the lease? If you have Suite A, with 4,350 square feet of rentable space, you are charged on rentable not usable square footage, which means that you pay for your fair share of that corridor, those bathrooms, and all other common areas. The rentable space of that floor is everything except the vertical penetrations.

So, there are areas that are used by, but not under the exclusive control of tenants, and those common areas have to be paid for. You subtract the common areas from the rentable to reach the usable number. Now, what really goes in the lease is a number that you compute. Suppose someone comes in wanting to rent some space and decides to rent a corner. When you deliver a lease, he calls you and says, “I was over there on Saturday and my tape measure said that I only had 2,000 square feet.” You agree with him that there is exactly 2,000 feet of usable square footage in that space, but his problem was that the contract said that he was paying for 2,200 feet. You let him know that, of course, he had to pay for his fair share of the common area, including bathrooms. Nearly 99% of all landlords use the BOMA method to calculate this. You may wonder why you can’t just charge them for the numbers on usable footage?

When you charge on a usable basis, your rate has to go up. You’re still trying to get $2,200 a month for this space. Therefore, you must charge about $1.10 a square foot per month.  The rentable area is 2,200.

Now, you can try to educate him, but he may go back to thatbuilding next door where he was only charged $1.00.You could try to give him a lower rate and just charge him the Common Area Maintenance (CAM), but no one else does that in an office building. That’s a retail convention because in a retail space, you are charging the net rent plus a CAM, but in the office building, gross rates apply. After you get all these things rolled together, make sure you’re measuring the building in the same way that everybody else does or you will put yourself at a material disadvantage.

Measuring Office Space (BOMA)

There are standards for different office space issues. One of the standards involved is how office space is measured. It’s not as simple as taking a measuring tape, determining the width and depth, and multiplying those two numbers together. The Buildings Owners and Managers Association (BOMA) International (www.boma.org) is an organization that has been the main source of information on building offices for 100 years. Over the years, BOMA has developed a very involved set of standards to measure buildings. Unlike warehouses, many office buildings are built on a square plan. If you have a building that is 100 feet x 100 feet, multiplying these two dimensions on each floor (10,000 square feet) determines your Gross Building Area (GBA) or Gross Floor Area.

Tip: Actually, whether you are talking about a floor or a whole building, builders use the same number and even the same language—GBA. Such terms as the inside surface of the dominant wall, the dominant part of the exterior wall, or the inside surface of the dominant wall to the inside surface of the dominant wall on other side are often seen in BOMA documents. Over the years, tenants and landlords agreed to modifications of these measurements. The changes occurred because some floors had vertical penetrations—for the most part, stairways and elevator shafts cut into the slabs. You can see that they are not useable at all to tenants and are not even really built. Hence, the argument is, they are not built for the tenant’s benefits. The tenant says, “Well, I would just as soon be on the ground floor. I can’t use that vertical space except to get in and out of the building.

The reason you have these stairs and elevators that I can’t use is because you didn’t want to build 50,000 square feet on the ground—you wanted to build 10,000 square feet on the ground and build five stories up. Why should I pay for that wasted space that helps me get in and out of the building?” The Landlord agreed that made sense and decided to rent just the rentable square footage—not the gross. To calculate the rentable square footage, you must take away the vertical penetrations. In this case, that’s 10 ft. x 20 ft. or 200 square feet.  The elevator is at least lOft. x 10 ft., so that’s another 100 square feet. The stairwell is l0t. x 20 ft. or another 200 square feet, so that’s a total of 500 square feet.

There might be other vertical penetrations, such as airshafts for air conditioning where they pass the chilled air up and down, and sometimes they have busbars, like single or multiple conductors, drilled and tapped holes, connectors, taps, or other components that need their own vertical penetration. In this case, there are 500 feet of vertical penetrations. After you subtract those figures, the remainder is 9,500 square feet, so this is the rentable square footage. If this is a single user tenant and there are no other tenants on this floor, the useable square footage is no different from the rentable—it’s identical. Usable means the space that you exclusively use and control.

Office Buzz Words

Load Factor

The load factor is the fractional part of the rentable divided by the usable (RIU number), the RIU number being the fractional part. It’s the amount that you multiply or add to the usable to get to the rentable.

Tenant Improvement (TI)

TI is the allowance tenants are given when they build out for moving into a brand new space that’s not built out yet. How much money are you willing to spend to fit this tenant’s space, to build the walls, put in the millwork and carpet, and all the office necessities? If you say $35, although $35 would be a fairly austere space, it also means that if the tenant rents 2,000 feet, you’re willing to spend 2,000 times $35, or $70,000, to finish that 2,000 square foot office space.

Now, that’s a completely gutted, brand new space. Either it can be renovated or it could be brand new space for just constructing that building. If you were in Orlando, that’s about what you would give the tenant in TI right now. If you rent older space, as a second, third, or fourth generation and a tenant goes in and says, “Yeah well, this fits me okay, but that carpet has to be from the Napoleonic era. We need to get some new carpet in here and repaint the place. It looks like it hasn’t been repainted in a long time and there is a smell coming from that one office.” You are going to need to price out accommodating that request versus waiting to lease to a less picky tenant in that kind of situation.

Refreshment

Your tenant will want to know how much you will spend to refresh that space. Determine the specifications and he can refresh it, or you’ll refresh it to his standards. That’s what is called second-generation refreshment, when you deal with an older space.

Right now in Orlando, for example, refreshment is going to cost you probably $5.00 or more per square foot of leased space, depending on how the space has deteriorated over time. The good part is this: if you lease office space, you’re typically signing a five-year lease, so you can feel a little more confident that you’re going to get your money’s worth, when you put some money into that space.

You can’t amortize a brand new space over five years—it would take you at least ten to get your money’s worth from that $70,000. It’s an amortization issue, because you have to take that $70,000 and spread it over a period of time.

If you’re already signing a five-year lease, you’re going to recover all the money, but then you have no return on your investment. You’ll probably recover all your money during that five years, but you need to amortize so that you get paid for the whole building.

When you have office space, you are constantly thinking about these issues. You “sweep out” industrial space every time you change tenants, so that’s the most money you will spend. Retail is about the same. However, with office space, one of the key factors is ensuring that the space always looks as nice as it can or people won’t rent it.

Office Buzz Words

Moveable Walls

Smart buildings also included moveable or demountable walls. Initially with a wall like this, you could cut rooms in half, but that was a fairly primitive moveable wall. It didn’t have any electricity or plumbing in it, so it wasn’t as useable on a permanent basis. For example, this might present a big problem for a landlord who has an older, used building, if his tenant walked in and looked at third or fifth generation space and commented, “Well, this looks pretty good, except I need that wall moved about 14 inches that way.” To accommodate that tenant and move the wall in this office, you must tear it down and build another wall 14 inches away. However, ceiling tiles are in a grid format and hold up the lights. When you move that wall 14 inches, the wall doesn’t line up with the grids anymore. So, you have to redo the ceiling grid to accommodate that 14-inch wall. You will also note that the carpet doesn’t match one side to the other now, so you must re-carpet as well.

A doorway, including the door, costs approximately $1,000 in a used space. When you build it brand new, it doesn’t cost nearly as much. So, the most expensive thing you can do as a used building owner is to move a wall. Nowadays, you can buy a wall system that floats into place—it just presses into the ceiling grid and the floor. You can put it in after the floor and the ceiling are installed and it can be moved 14 inches by unskilled labor. This system has electricity or even plumbing in the panels, so you could actually modify the configuration of the plumbing and electric when you move the wall. For instance, if you have a tenant who is a lawyer with a ten-year lease, he will probably reconfigure that space from time to time in those ten years, with personnel changes. They may need larger or smaller offices, so you may need to make changes.

A movable wall system is just right for this situation and for that type of project. One efficient and economic method to use in a project involving moveable walls is to do all the carpeting and ceilings before you put in the walls. For instance, if you carpeted a 7,200 square foot room all at once, the cost is dramatically less, than if you first build the walls and then laid the carpet. The electric for these walls is purely generic and snaps into place, but if you want water in a wall, you have to order the panels that way. They come at just a certain place, so no matter what wall panel you match it up with; it’s going to hit the spot. Then, there are terminuses, where two walls come together.

These panels cost twice as much as anything else. A building project like this usually takes six weeks to get a permit, and then about two more months to build it out. So, if you had tenants waiting, it would be almost four months before they would be able to get in their space—the major holdup being the building permit. Then, they construct the floor in nine days, and take another week after that to finish everything else. The tenant can start paying rent two months earlier.

Now, if you have a second or third generation space like that and a tenant comes in who doesn’t want a 1,000 feet, but needs 1,200 feet, you have it to give-just move the wall and there’s the extra footage. You don’t necessarily have to pull a building permit because you don’t have to switch the electric on, unless plumbing is involved for which you haven’t already ordered panels.

Haworth is the main company that does this type of construction. They manufacture the best walls right now. You can go online to www.Haworth.com and look at how they build floors—the kind that used to be called, “computer floors.” The floors are two inches high and you can run all your wires. In other words, you can take an old building and make it lot smarter.

Office Buzz Words

Smart Buildings

A smart building isn’t necessarily very smart. During the seventies, heat, ventilation, and air-conditioning were automated HVAC systems. These first dedicated computers would turn the heat or the air-conditioning on in the morning, turn it off at night, and knew the difference between a weekday and a Saturday, Sunday, or holiday. Everyone began calling this is a smart building because it saved you a lot of money on air-conditioning. Later, those air-conditioning computers became really smart. They would allow you to adjust your thermostat to a controlled degree. For instance, if you tried to set the thermostat at 58 degrees, the overriding computer would only go down to 70 degrees— that was the set point. At that point, it would turn the air conditioner off. If the temperature rose higher than 73 degrees, it would start the air-conditioner.

Therefore, tenants began to have less and less control over their office environment. However, it had been a big waste of energy when different tenants controlled their own space. You might have had five thermostats in an office full of people who each thought that they knew best, what the temperature ought to be.

Smart buildings today do so much more because in order to compete they must build in high-tech communications systems. Buildings are constructed with fiber optics to every floor with a T-1 line for telephone calls and high speed internet.

Entrenched Slabs

Another smart building concept is one that is just now starting to happen, over the past four or five years. Every four feet some sort of trench is cut in the slab with a metal plate over it. Inside this nine-inch wide and three-inch deep trench is all the conduits and plumbing for the building.

You don’t have to actually cut through the slab, but you go underneath with your pipe and then back up. These trenches are everywhere—some of them are just trenches, while others are voids in the slab. There are no openings unless there’s an intersection. The nine-inch square metal plate is at each intersection.

This means that if you have the system underneath you, inside your floor, and you wanted to change some plumbing requirement, you can get it within four feet of any plumbing you want. Of course, electric and safety codes apply to all these devices. It’s the same way with electricity and telephones. Therefore, no matter what innovations and communications or electrical transmissions are required, the builders can lay a whole new system in the floor without destroying any existing materials—that’s a smart building concept.