I’m sorry this post is long overdue. It’s also a little lengthy.
No, we didn’t buy a giant high-rise building! It’s a one-story office condo with plenty of room for us though.
I mentioned previously that another purchase was in the works late last year. Well, we ended up closing at the end of December on an office building to move my existing business into. This purchase was made using my business account and shared with my other two business partners.
Originally, I had looked at leasing a larger office space to satisfy our needs. Our current space is only about 1600 sq ft and we needed a larger space to grow into. We looked at a couple of spaces that were around 2000 sq ft and they ranged in price from $20-$24/sqft triple net. This is a monthly cost of $3333-$4000/month. $4000 happens to be double the price we’re currently paying and we would now have to pay our own utility bills and internet usage costs. So we were about to incur about $2500 in additional monthly costs to get into a much nicer but just slightly larger space.
If you’re not familiar with triple net (NNN), basically it means the tenant is responsible for taxes, insurance and maintenance on the building. This is fairly typical in commercial real estate and much be accounted for when looking at monthly costs.
I then had the idea of possibly buying our own space. I crunched some numbers and partly had my business partners sold on the idea. The next problem would be finding a suitable space in our price range. We still wanted our P&I costs of the purchase after down payment to be around $4000/mo or lower. After looking at a few properties, what we discovered was that we could get a much larger space for the same price as renting!
The main reasons for the purchase:
1.) Elimination of rent
2.) We needed a larger space
3.) Investment opportunity
4.) No landlord to report to
5.) CHEAPER!
6.) Kegerator! Yes, we will have a kegerator in our kitchen!
So we settled on an office condo “shell” unit. This means the inside hasn’t been built out yet. That’s ok because we could include our build-out costs into the financing from the bank. The unit is a stand-alone unit with approximately 3300 sq. ft. It was built in 2007 along with about 6 other units in the sub-division. Most of the units have been sold now and contain medical businesses. We would be one of the only tenants not in the medical space there.
We then made an offer and went back and forth with the seller before settling on a price, approximately $680,000. We only needed to wait on the appraisal to come in at the value we offered.
The problem with a commercial appraisal is that it is about 10 times the cost of a residential appraisal! Yes, we had to spend over $3500 on an appraisal that was non-refundable! So, in addition to our earnest money of $10k on the line, we had an additional $3500 plus options money of $100, for a $13,600 investment already tied up. This did make me a little nervous.
When we finally received the appraisal, it came in about $15k under the purchase price. Thankfully, the seller was willing to reduce the price down to meet the appraised price. Otherwise, we’d have to fork over an additional $15k down payment.
Now we just needed to secure financing. This was the next biggest hurdle.
Here’s what our bank wanted initially:
1. Interim financial statement for Business as of 9/30/13, if available
2. Current accounts receivable and accounts payable agings
3. Current business debt schedule – form attached
4. Three years personal tax returns for all members
5. Copy of the executed contract
Once this was done we had some rates and terms proposed to us. Basically with a commercial purchase, most banks won’t let you have a term over 20 years. While this means you’ll pay less in interest, it significantly increases your monthly P&I payments. This is also different from residential loans where you can easily get a 30-year fixed rate.
There’s also a lot of loans with pre-payment penalties and balloons in commercial. A 20-year fixed rate with a 10-year balloon means that after 10 years, the total note is due. You either have to come up with the entire amount left or you need to refinance.
I’m really not a fan of balloons. Image what could happen in the midst of another financial meltdown. If our balloon ended in another financial crisis, I might not get approved for the remaining money. So the balloon option was out of question.
We decided on a 20-year fixed rate of 4% with a 5-year adjustment period based on rates at the Federal Home Loan Bank of Dallas. This is sort of like an ARM in residential. Our plans are to pay off this loan within 5 years so we don’t have to deal with our rate going up.
Next the bank needed the following:
1. Proof of insurance on the project – not sure if your contractor is going to carry builder’s risk or if your hazard policy will cover it. You might want to go ahead and start working on this as sometimes it takes while.
2. Information on the contractor such as previous experience, contact info. List of references and/or trade accounts
3. We will need a proposed lease between your business and the new LLC – you might want to get your attorney to start working on this also.
4. Corporate docs for your company as they are proposed as a guarantor. Who will sign on behalf of that entity and their title?
5. Please provide us a copy of either your bank statements or account analysis statements and we will prepare a depository bid for your company. These statements will allow us to accurately bid the amount of deposits/transactions in your account each month.
6. Please complete the attached worksheet for all three proposed signors on the accounts/loan and provide a copy of each valid driver’s license.
7. Please double check that your company is in good standing with Texas Sec of State. We will require this to be clear.
What we did was start a new LLC as a holding company for the purchase. My current company would then pay rent to the new LLC which we also owned. This was advised by our accountant for not only tax purposes but for easily separating the two businesses.
Once the rest of the above was satisfied we were basically clear to close on the loan, this happened at the end of December.
I mentioned that we wanted about 2000 square feet for ourselves. Well our new space has approximately 3300 square feet. We decided to partition the building into two main areas with common break rooms and bathrooms. This means we have 1000 square feet of rental space that we plan to lease out. Based on rates in the area, this could bring in up to $2000/month.
After all bills and renting out the other section, our estimated costs are about $2500/month. This includes utilities. This is also much cheaper than the $4000/month we were looking at for rent!
So not only have we made an investment in commercial real estate in the booming Austin economy, but we should lower our expenses in the process.
We’ve now finished the architecture drawings and have submitted our proposal to the city for construction. We’ve had to meet with the architect and construction company multiple times in order to get the place designed how we want with our budget.
Construction should start shortly and we’re planning on moving in sometime in late May or beginning of June.
This should catch you up on where we are at currently. I’m sure I’ll post another update once finished or close to finished.
You can find all of my real estate posts by clicking on my real estate label.
Interesting. I didn’t know the process of buying commercial real estate. Thanks for this post I find it informative.
So roughly the loan is going to cost you $4,500 a month ($2,500 net after the $2,000 for renting out next door).
Thats higher then your rent. Is that something you guys can afford if it sits vacant?
Of course, depreciation will give you some great benefits too so you will recoop that some.
Pulling Myself Up,
I’m glad you found it informative. It’s certainly a different process for commercial real estate. I don’t think we’ll have trouble renting the other space but we’ve factored that in and are able to pay the whole note even without a renter.
The only problem with depreciation is that you have to depreciate it over 39 years. Don’t ask me how the IRS came up with that number but that’s what you have to do for a commercial building.
Thanks for stopping by!
Awesome! The separate rental LLC is sound advice (and very common). This will allow you as partners to maximize the benefits of owning the property and generate income for yourselves independently. Should you decide to sell the property, it wouldn’t be tangled up with the rest of your business. All the way around you’ve effectively boosted your personal incomes with this purchase. Definitely an awesome move!
w2r,
I think you’re right. I don’t think there’s a lot of tax savings this way but we get the liability protection and are able to separate the two businesses easily. I think this will be a nice long-term move for my business.
Take care!
Congrats AAI. I used to be involved in projects like yours, I know that buying/selling commercial is a different animal. The great news is that your business is now paying for another asset that belongs to your family! I love it when I don’t directly pay for assets.
-Bryan
Income Surfer,
Thanks! It certainly is a different animal, especially the construction part of it that I’m dealing with now and all of the permitting.
I have to agree, it’s great to be spending the same amount of money for something but be slowly paying to own the asset.
Cheers!
That is big business!
You are like O. 😉
Can I purchase some shares from AAI ? 🙂
Best whishes!
D-S
Hi D-S,
Haha, I don’t know about like O but will take the compliment. O had to start somewhere right? My target is for 10 rentals in addition to the commercial office space. I still have a long ways to go.
Thanks for dropping by!
Great job. If you need Real estate tips, please stop by my site.
No Nonsense,
Thanks, I’ll be checking out your site for sure.
Thanks for stopping by!