Commercial Real Estate Investing From A-Z My First Commercial Real Estate Offer: What Happened (Part 3 of 3)
In this and final episode, I'll go over the financials and how I made the decision to move forward (or not!) with the purchase, and then we'll come to a conclusion at the end.
You can read the entire episode here: https://montecarlorei.com/my-first-commercial-real-estate-offer-what-happened-part-3-of-3/
When we made an offer on this theater that had been abandoned for 30 years, we had three options in mind:
1. Do a very basic remodel and sell it.
2. Go all the way with the remodel, bring the property up to an impeccable state, and run it as a business: running events such as corporate events, weddings, parties, etc.
3. Remodel as much as we should, rent it out to a tenant, and decide then if we would sell it or keep it.
Since we were unsure how the economy was going to go by the time the construction was done, we had to be very conservative. At the time of purchase, the cap rates were at around 6% for the area, and we wanted to think ahead and in case the economy took a hit, so we also ran the numbers at an 8% cap rate. Why? When the economy tanks, cap rates to go up because people are able to buy less property (because interest rates are higher and banks are more conservative), and there are more "discounts" happening (because less people are buying), that's why we had to calculate an increase of 2% in the cap rate, just in case that there be something going on in the economy by the time that the property was fully remodeled. This is a very important calculation for all of us at this time in the economy.
Calculation breakdown for construction costs:
Construction costs: the best case scenario was $780,000 of renovation costs, the medium case scenario was $1,000,000 of renovation costs, and the worst case scenario was $1.5M of renovation costs, plus the purchase price of $430,000. At the worst case scenario, we could have ended up with almost $2M in total costs, in which case we’d definitely have to sell above that number.
Options for what to do after renovations, and their associated costs:
1. With our first option of doing the very basic remodel of $780,000 of minimum renovation and selling the property for a worst case scenario of 8% cap, we would be making around $200,000 – at this number it was not worth the headache for us.
2. The number two option was to remodel incredibly well and run it as a business and do events. For this option, I contacted quite a few events places in the area and I found one place that was very comparable to ours. They were charging around $5,500/event which included security, tables, chairs, linen, staff, water bill, electricity bill. I estimated that out of that $5,500 we would probably end up keeping around $2,000-$3,000 per night. In the worst case scenario we would rent it for 40 nights per year, and in the best case scenario we would rent it for 60 nights per year. I was also adding a revenue for a church to hold services on Sundays for a few weekends during the year. At the end of the calculations, our net income on the worst worst case scenario would have been around $110,000/year, in the best-case scenario would have been around $160,000/year, however this was very conservative at a net revenue of $2,000/night.
Out of these three options, we were calculating the least amount of construction costs that we were going to incur, as well as the highest amount of construction costs. Because we didn’t know exactly how much the construction cost would end up being until we started the construction, we had to understand the minimum cost, and the maximum costs we could end up incurring.