Episode #097 - 5 Ways to AVOID RISK When Purchasing Your FIRST Commercial Real Estate Deal!

Today hosts Braden Cheek, Brian Duck and Joel Thompson discuss 5 ways to effectively mitigate risk when purchasing your first ever commercial property!

What is up and welcome back to how to invest in commercial real estate today. And we have a cool topic today because I think a lot of people here or frankly, probably not invested in commercial real estate. Maybe this is your stop to get educated. Maybe this is your first resource and maybe you know, your first time investor of ours. But I think a decent amount of people listening and watching probably have not bought a commercial real estate deal before. So we've got an interesting topic to maybe avoid some risk on to go into that deal. But first we wanted to take a minute and stop and talk about the criterion building up in a law. So it is finally open. We've got Keller Williams, we've got a medical spa beauty farm, we've got us hair salon birch and co, our offices opening up. We finally have furniture in there. It's looking great. And most importantly our coworking space is about to open. So if you are local, if you're Tulsa Owasso or anywhere on the north side of town really we have an amazing new coworking space with state of the art stuff.

Um, it's all wireless kill a century. Everything is included, tons of cool packages and you can get involved in that for $100 a month. So I know for me when we started our business in Owasso, I need an office space right? And the cheapest thing I could find was $600 a month and it had like the shag green carpet. It worked at the time, but that was just the office, I had to go and get wifi, that was $400 a month. I had to buy my own coffee. I did, I did do all these things my own printer, although I didn't have a receptionist, I didn't have a place to have conferences, didn't have a conference room, had to buy my own furniture right at the coworking space. All of that is included $100 a month For $100 a month. But wait, there's more, I'm just kidding. Anyway, as you can tell, I am super excited about the new coworking space in Owasso and that is going to be up March one. So if you're so stop by checks out the new criterion building. Do we have any type of referral plan that if people listening to the podcast tell someone and they come in and like, hey, I want to, I heard about it from so and so they saw it on your podcast, we give them anything.

Yeah, yeah, I'll give you 25 Bucks. Okay, $25 just in the page. My man, Aaron will get you taken care of it's done people so you don't get any other money you want to give away? Live on the fly. I mean any other people using the coworking space? That's what I want, that is the deal. But anyway, back to real life. Um first real estate deal, right? Like we're listening to the deal to get educated to find out how to get involved. We're learning that this is a beneficial asset class or something you may be interested in. So how do we avoid risk on the first deal? The first one you wanna hit a homer maybe, But practically it's like let's just get on first base, how do we just not mess this up? How do we not lose everyone's money? Like how do I get in my first deal and not have it be an absolute disaster, right? So We came up with five reasons. Sure, five reasons that five ways 5 ways again. But let me take a step back. You know, why haven't people that want to get in commercial real estate? Have they not purchased their first deal?

And there may be a bunch of reasons, but I would say a big one is fear, fear of losing money, fear of not knowing all the answers, you know, and and that fear holds them back from taking action and buying that first deal. So we came up with ways to reduce risk on your very first deal because we think it will help combat that fear that knowledge combats that fear and it will give them the confidence to move forward and finally get in the game. So yeah, well I think the first one is uh maybe buying something you think you can afford right? Like buying the smaller deal, buying the deal that's been on the market forever, buying the deal that's in a bad location, or buying the deal that's in a small market, right? Like you're going small, you're you're scared, you're dipping your toe in. But in a sense, we kind of need to jump in, right? Because a nice asset that's worth owning and pays out cash flow, that's that's worth having is probably a bit more expensive than than you initially thinking. So you're saying that's a fear that people have, is they're worried about buying something really small, or they're worried about they're worried about buying something too big.

And so they go to buy something small, doing that, they sacrifice some of the fundamentals and look for for a seasoned commercial real estate investor, they may be able to find a gym that's off the beaten path that nobody knows about, but that is inherently risky because of where it might be, or because there might, you know, be some hair on the deal in some way. So what we're saying, encouraging them is take a step up by a better quality asset for your first one. Yeah. It's gonna feel like you're paying more, but it will hold its value more and then that there's less risk. Yeah, we need to build a track record, we didn't have wins. And the idea of this whole episode is, let's not mess it up money, right? So you buy a great asset at first, it's going to be more expensive than the thing and like some pulp a or you know, maybe the middle of nowhere, wherever you live, it's gonna be more expensive than that. You want traffic counts. You want people living by, you want something that looks looks really nice, right? That's gonna be more expensive than something that doesn't look really nice. So we just need to get that in our head.

You don't need the most expensive thing. I'm not saying go to the best part of your sub market and try to buy the whole foods. Okay. That's not what I'm driving to. I'm just saying at some point we need some traffic counts. We need some people, we need some jobs, focus on some fundamental and so what someone might need to do is instead of thinking, okay, well I'm gonna buy this by myself. I wanna, I'm gonna buy a better property. I'm gonna get some people to invest with me, right? And that reduces the risk. Yeah. Don't worry about not affording it upfront. Like let's just, you know, at some point you have to set a parameter. You know, like maybe we need to stay under $5 million. But if you're looking at a $2 million asset let's expand that to maybe four or five and and think of some other creative financing options, like bringing on investors or bumping up your leverage or whatever. But that's kind of the separate topic. Just generally speaking by an asset worth having. It's not the cheapest asset that you can afford. Okay, number two, this is something we focus on a lot and I think it's important is we're not massive speculative deal. People, we don't typically by the, the empty building and going with the strategy of the massive rehab and this massive lease up that's typically not our general deal.

Right? Why? Well, we, we like cash flow and so we try to buy as many deals as we can, that cash flow from day one. and that reduces your risk because we're not dependent day one of finding a tenant or filling a bunch of vacant space to make the deal profitable. Yeah. So when you're buying a piece of real estate that doesn't produce any cash flow, it doesn't have any tenants. You're having to try to underwrite what the cash flow could be because at the end of the day, you don't really care about the inherent value of the real estate. As long as it's in good enough position to get you the cash flow you need, so you need to, you're trying to backfill how many tenants you can get in there, what's what rent they're gonna pay and again, it's all speculative. You have no idea if you're going to get tenants or what they're going to pay at all. Right, we're going and buying a retail center or any other building for that matter. And it is full of tenants that maybe been there 5, 10, 20 plus years. You know, they've ran that business in that location at that spot. Being able to pay their rent, not get kicked out and still make a living, right? It's a business worth owning. You can underwrite that you can take that to the bank and get a loan on it. You can show your investors, Hey, I've got a dozen tenants that have been here on average, 10 years.

We've got lisa's rolling, you know, throughout the next five years of our holding period. You know, all we need is a 3% rent increase. That knowledge is helping combat fear. Like you said in the beginning, it's, it's helping raise money from investors. It's helping secure your loan from your lender instead of you trying to tell a story about this empty piece of real estate that doesn't make any money. Nobody cares about your story. And it's way harder to do. And again, on the first deal, we're trying to not mess it up. We're trying to not lose their money. Yeah. Well, the other thing is if you buy something speculative like that, it's gonna take a lot of heavy lifting, right? And so now you're out doing all this heavy lifting after you bought this thing and that keeps you from going out and finding your second deal probably right, because you're working so hard to get at least up. Or maybe you have to do a lot of, um um rehab rehab whatever. Yeah I I would say that the least amount of unknowns is gonna be the best for your first deal. And so like you say you're trying to speculate on how long is it gonna take me to fill a vacancy?

Uh You know how many tenants do I need and what what's the rent going to be when I do feel it? And how much is the T. I. That they're gonna demand? The thing is you don't know that for sure. So yeah, you may have a good idea and even a more seasoned professional might have an even better idea, but it's still you're adding unknown after unknown to your very first deal and on your first one you need to win because that'll keep you going if you fail on your first deal, you know may discourage you. So that's a perfect segue because it's things are going to fail. Shit happens, life happens, right? So like in this next point we need to have some extra cash. You don't go into this thing saying, okay I'm buying a million dollar property, I'm getting $800,000 in loan proceeds, I need $200,000 in cash. Like no dude, you need like three or $400,000 in cash, Something is gonna happen, parking lot gets older, it's gonna snow, it's gonna tear it up, your roof is gonna leak, your roof is going to get older, Your H. V. A. C. Units will stop working. Eventually you will need to replace those. Your tenants are gonna ask for money, they're gonna ask for free rent. They may leave, you may have to pay somebody to get a new tenant in there.

You may have to pay for the tenant improvements to get the new tenant in there. Right? So like stuff is going to happen that's not a failure. That doesn't mean the deal failed. If you didn't have the money maybe that would be the end of the deal, maybe that would fail the deal. But if you have the money you're able to reposition the asset, you're able to pay for the new tenant, you're able to pay for the loss of rent, you're able to pay for the new roof, you're able to pay for the new parking lot because you said in the beginning, hey I know something is going to happen. I need to be prepared please. So we're saying just have some extra cash available. A decent amount of extra cash on your first deal. You need you need to go in and that will reduce the returns once again you you don't I wouldn't worry on your first commercial deal about maximizing returns, I would worry about ensuring the returns whatever those are. Uh So if you have to, let's say the deal will return 12% cash on cash but you're gonna have to raise extra money to be really safe and secure in this first one in case something goes wrong and it drops your returns to eight. Well, eight on your first deal. If you can secure that kind of return, that's gonna be just fine and your assets going up in value. So it's better than eight the cash flows eight.

So make sure you have plenty of cash on that first one to rule with them. Let's try to give him a rule of thumb if I'm buying a million dollar just to make it easy, a million dollar deal and I'm getting an 80% loan, that's 200,000 in equity that I need. Uh, I tend to, you know, probably go with 25 to 40,000 in closing costs, various things from the legal docs to the closing fees and title insurance and then on a million dollar property, I would probably go in with an extra $100,000 in reserve. Now that goes up to $2 million deal, maybe it's not 200 maybe it's 100 and 50 175 $3 million deal. Maybe it's $205 million 300. So let's continue to break that down a little bit because you're going to say $100,000 on a million deal and actually 10% some might say, but on a million dollar deal, you know, let's just maybe $100 a square foot, maybe have 10,000 ft, right? So 10,000 ft of roof roofing right now is maybe $7 foot $70,000 gone Now. You don't even have enough money to replace your parking lot.

So $100,000 is guaranteed to be spent right there. Yeah, but hopefully you're, you're making sure that that if it needs that stuff going in, you're going to reserve for that as well, this is an excess uh for the unknown because this is your first deal and you're an experience. You don't, you may not know any anything and everything that could go wrong. So let's set the roof in the parking lot aside because if that needs your place, you have to raise for that as well. This is for uh you know, someone ramps the building with a truck when they're drunk, like we've had some of our centers or attended or to move out and you've got to return at that space with brokerage fees and and leasing commissions. So yeah, so that it's just for that stuff. Yeah. Just for every one of these reference will will overdub the clip of somebody smashing through our building in the U. Haul truck at two a.m. But like life happens right? It took us 90 days to get the insurance check from that, we're still working with getting it repaired, getting intimate happy like stuff is gonna happen and that property pays out great cash flow. It's a good thing we had the cash to flow through repairs until we get the insurance money in any way. I know at this point you're thinking guys I've listened to almost 100 of your episodes.

I'm invested in several of your deals. I'm a pro in commercial real estate. I'm gonna go buy my first one. I've read the books. Rich dad, poor dad. You know I know what I'm doing. I'm gonna manage it. I know what to do. You guys talk about lisa Nichols camp caps. I'm a pro that I'm telling you I don't manage a lot of my deals for a reason. Your first deal you should not manage, you're gonna miss something if you try to manage it yourself right now don't don't manage your first one. Uh You want to hire a third party manager in the market that you're buying in and you want to learn from them and there they may even miss something. Uh There's just things that that are gonna come up. But the thing is you won't know if you've missed it and and we just want to make sure that you don't get into a situation that you are trying to manage it. You missed it. You didn't do the camera X. Right? Uh You know things when you get behind the eight ball and it ruins your first experience. Plus that's that's not your job like brian said earlier your job is to go by these deals and make sure they're paying out their scheduled cash flow. You set the property manager up with a budget and a tolerance and and they've got the cash to make decisions, you know maybe +257 $10,000.

Whatever parameters you set, they work on a feed that your tenants are probably already paying for. So yeah, if you want to save that money then take a year, learn what they do, learn the reports, get a good handle on it and then maybe take it over in a year or two years. But if you don't, if the deal doesn't work without third party management you shouldn't be buying it as a as a beginner. But if your local and you don't like headaches call Joel, he loves headaches and he third party property, third party management for you. Boom. Alright next point um Underwriting right Like we we've got to look at this, we've got to figure out what the cash flow is. We're not buying an empty building. So there's tenants, there's leases, there's there's income we could be making I would say a three year budget at least of income and expenses off of the leases. Three year budget, three years of principal and interest payments. Three years of what your expenses are, three years of your income, three years of your net cash load your investors who are at least what you hope it to be any capital expenditures that you may spend. Excuse me.

But and so that you should know how to do all that before you're buying a multi million dollar commercial real estate deal. What we're saying is get help with that first deal underwriting. There are third parties that will do help you do that underwriting to make sure you didn't miss anything. We can recommend some uh you can also have your banker. If you let's say you really know your lender well as a buddy or something, then have them underwrite it and see if they can see anything any risk points. But don't go in and just say, well I'm the only one that looked at this and I watched all the classes and I read all the books and I'm just I'm not gonna miss anything on the underwriting that that that set you up for risk. You may get it right. But if you don't uh you could lose my first deal. I'd like to study it. Like you said, personally come up with my own then maybe get a third party. And then of course um the bank's gonna do it as well. Right? And so I would feel a lot more comfortable if I had three independent people underwriting my first deal. You had a lot of this stuff. It's not like you you are doing it in consecutive order right after another.

You're you're doing it. Co terminus lee right? Like your underwriting the deal initially you're saying, okay, this looks good. This pass the sniff test. I may go ahead and get this in contract. I may start inspecting it. But as soon as you get in contract, one of those inspections is a third party underwriting your lender. He's gonna do it. Obviously you're gonna start to look for property managers. You send it to them. Hey, I've got this property under contract. Here's the due diligence materials. Here's what I'm thinking. It should bring in is that jive. You know, you're gonna have these conversations before you get the closing. You're not gonna close on this thing without some sort of budget from, from somebody. Somebody's gonna help but just make sure it's sooner rather than later have those conversations. Is that all the ones we have for today? Nope, Last one. So we buy a lot of stuff out of market. But for your first deal you should probably stay in your pocket, You should probably stay local. You should probably have a good understanding of what area the town. What what area of the town is in is doing, where the growth is going, where the new jobs are, where the main traffic corridors through your cities, where the suburbs are, where the city is. You know, you need to be able to pinpoint this and and tell that story to yourself to your investors, to your lender, to your property manager.

It needs to be something you believe in and going out of market. I think you said it before the show you're just adding risk when you, it's another layer of risk and another labor expense because you've got to get there. Uh, and, and it takes time and money just to go view the asset and maybe view that market. And also if you're going to buy the market, you don't live in, you're gonna have to get advice on that market and how the property that you're looking at and where it is and how good it is and what school did and traffic counts. Well, that's your, depending on another human now. So it just adds another layer of risk even though they're probably telling you, you know, what's accurate if you can just buy in the market you live in as long as that market is sufficient size. So if you, if you live in a small, really small town, don't, don't buy your first deal local. Uh, you know, go to a town that for retail, I like to have about a million people. Mm essay especially on your first one. So the town, the city can be half a mil, but it has a metro area of about a million people.

That that's probably a good sufficient size. Multi family. You can go a little lower maybe, maybe a couple 100,000 people just because it's a more stable asset class. But you know, a lot of these small towns, uh, the winds, so to speak and can shift and change as far as population growth there may be dependent on a factory or, or some other big business. And so the towns that were booming 100 years ago, we see them all the time, they're dead today and you don't want to be in a position where your market starts declining because it's just too small. Once it, once markets get to a certain critical mass, they're gonna grow or they should theoretically continue to grow for decades. Plus the goal is to not mess it up, not lose your money at the end of the day. If something happened, which something's gonna happen. But it's just a matter of whether or not you were prepared and whether or not it took you down. But if something happened, do you want your first deal, your first one? All of your investors coming back to you, You're thinking, what are you thinking? Why would you buy your first deal 500 miles away from you? Like why would you do that? You're gonna have a hard time convincing investors on the second deal, if you mess up the first one.

So like Joel said, you're gonna get discouraged probably. And if you, if you buy in a small, uh, you know, a small market, you may not have a buyer when you want to sell because there's just a limited buyer pool for, let's say, you know Wagner here in Oklahoma outside Tulsa, like, you know, it's not gonna be easy to sell deals like that. So pick a good size market that you either live in or are really close to. All right, well, I I think that's helpful on your first deal. You wanna go big, you don't want to buy something empty, you're gonna have plenty of excess capital for reserves because something's gonna happen. You're gonna go in with the management team with you. They're gonna help you underwrite it. Your lender is gonna help you underwrite it. You're gonna have this team of people helping you underwrite it. Seeing the same things you do as far as free cash and it's gonna be local guys. I mean, it makes sense for your first deal. Those five reasons should keep you like, if you're going into your first deal with those five things at the top of your mind. Yeah, we're trying to, those things will reduce your risk, it's not going to be zero. Your risk isn't gonna be zero, but it's going to be way lower. If you follow some of the points that we're trying to convey to you anyway.

I think that is it for this week's episode of how to invest in commercial real estate. We will see you guys next week