There’s a small niche market for a certain types of investors.  The types of properties in this niche market are called Value Add properties, and these investors usually have three things.  A great deal of cash…a sophisticated team including their real estate broker and contractors, and the stomach to take some big and risky leaps.  Chances are you’ve seen these properties just in your daily commute.  The empty office buildings, the rundown apartments and the retail center that USED to be nice but now it’s just so worn out.  These are the type of properties that for the right price and the right investor can make huge amounts of income over time…if you have the right stomach for it!

First, let me touch a bit on how valuating commercial property works.  Here we have a $1M office building. Let’s say it has 20 different spaces that it could rent out, and only 2 of them are rented. Together, each unit pays $1000/month.  If you remember from my “Commercial Loan Process” video, a commercial loan has to pay for itself and THEN some.  With the building listed for $1M, there is no WAY you could get a loan that’s under $2000/month!  Just in taxes and insurance alone would cost you more!!

But wait…if the whole point of commercial investment real estate is to make a profit on the rents…why would I buy something that’s going to make me a NEGATIVE cash flow every month? And this is exactly where the value add comes in!

The first catch is that you have to buy this property with cash or with a hard money lender as I discussed in my “Hard Money Loan” video.  You may be buying this property for $1M, but the good thing is that it would cost you MORE than that to even BUILD it from scratch…so you’re already one step in the right direction.  Not only that, but at this price, you could just undercut all the other office landlords and rent your remaining 18 units for $750/month.  With that, you can fill it up in NO time!!  Now instead of just $2000/month, you’re making over $15,500!  This easily translates to a high positive cash flow!  Once the property is stabilized with these tenants for a while, you have a few options.

First you can improve the building and charge the tenants more money once their leases are through.  This adds value to your property – making it more desirable – and makes tenants more acceptable to paying higher rents since they’d be in an upgraded building.  Secondly if you choose, you could refinance the property.  This will free up some funds that you initially invested so you could reinvest elsewhere.  Finally you could “flip” the property for a profit!  Without getting into detailed numbers, if you do your research and find that OTHER similar office buildings which make about the same monthly income of $15,500/month are selling for $2M, then your property is likely in that same range.

For those of you that are a bit more comfortable with homes, let me compare it to a residential value add.  We all probably know it as “flipping houses”.  There’s a $250k house that’s completely gutted…no one wants to buy it all cash when they can buy the neighbor’s house for $500k. Someone comes along and figures that they could do the repairs themselves…and after a few months and about $100k, the home is worth $500k just like the neighbors.  You add the $250k home price plus another $100k in rehab, that’s a $150k profit.

There is a final catch to all this as well.  There’s always a potential for something to go wrong.  For instance, let’s say that you’re unable to rent out the units for $750/month, and instead you have to rent them out for $500/month…what is that going to do to your projections?  This is why you have to be able to weigh your risk vs. what you determine will happen in the future with as much analysis as possible.

These niche value add properties aren’t usually easy to find.  And like I mentioned before, they come with a HUGE risks.  This means that even though there MIGHT be a HUGE payoff after the project is completed there’s also a chance you only break even or even lose money.  Most people are completely comfortable making a safe 6-12% return, vs. risking it to make 15-20%.  This is why having a sophisticated team working for you is essential.  You need to have everything lined up before you even attempt to buy a value add type of property.  Weigh all your risks, do all the research and analysis you can, and if you’re confident — and have the stomach to make some huge profits — then go for it…now that’s good to know. 🙂

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