Vancouver Commercial Real Estate Podcast

Want to return 100% cash on cash on your commercial real estate investment in less than 36 months? Discover 5 criteria you need to make this happen and execute on a proven strategy!  

On the Bank of Canada’s recent rate hold:  

The Bank of Canada held their rate. Some people thought we’d see an increase like we saw in the US, Great Britain and Australia. Others thought we’d see a hold. So it was a mixed bag going in but we’re happy to say the Bank of Canada did hold their rate. I think that will create some more confidence in the market. 

It sounds like there’s even an opportunity for the rate to come off this summer if you read the meeting notes. There’s hope! 

5 Criteria Needed in Your Commercial Real Estate Investment to Return 100% Cash on Cash in 36 Months or Less 

Criteria #1: You need to find a value-add property within a market that has seen no less than 80% rental increase over the current leases in place 

For example, let’s look at industrial class B in the Greater Nanaimo area. You can find legacy leases where tenants are paying $7-10/square foot. Market rents are $16+. If you buy a building where the tenant is currently paying $9 and they are moving out or their lease is up for renewal, you can lease it out at a market rate of $16, hitting that 80%+ threshold. 

Criteria #2: You need to have month-to-month leases or the aggregate average of the building’s leases need to be less than 24 months

Leases need to have terms, traditionally with 24 months or less, in order to make this strategy work. If a tenant just signed on for a five year term at $10, you can’t change that to $16. The leases need to be on month-to-month terms or have less than 24 months left so you can extract the market rate as soon as possible. 

Most traditional lenders won’t look at buildings where the future income is double what it is today because they can only use the current income to service the debt. So you’ll need to go to a lender or broker who has access to bridge lending, which you’ll utilize for 1-2 years, until you can update the rental rates and refinance.

Criteria #3: Ask questions: What is the lease term? Is it a gross lease or triple net lease? Does the tenant have the option to renew? 

It’s important to know if the tenant has the option to renew because with larger or AAA tenants, their renewal rates may be fixed. Those rates might be a fixed number or tied to CPI, meaning you can’t extract the full market rate.

It’s also important to know if it’s a gross lease or triple net lease. For example with a gross lease, tenants pay $20/foot and the owner has to pay all operating costs out of that $20, similar to residential rental rates. With a triple net lease, tenants have a $20/foot base rent, but still have to pay all operating costs on top of that. 

If a gross lease is in place, the new owner often has to renew on a gross lease. This is a challenge since building costs, property taxes and other operating costs are going up. That’s why understanding the lease type is so important. 

In commercial real estate, there is no maximum to what rental rates can increase after a lease term, unlike residential real estate, unless there is a fixed renewal rate in place.

Massive rate increases are seen once in a generation, like when Yaletown went from $40 to $80 per square foot after the skytrain moved in. That’s why it’s so important to choose a property in the right location. 

Some buyers are very familiar with leases and may choose to go through the leases themselves. Others choose to consult their lawyer and get a summary. 

Criteria #4: When you are looking to acquire these buildings, look for minimal construction risk

Construction costs have skyrocketed in recent years. You want to buy a property that has minimal construction risk. For example, you don’t want to be adding in a sprinkler system, changing out knob and tube wiring and copper piping, etc. There are a lot of horror stories in commercial real estate. 

You need to understand the construction elements of your building. Structural changes to the building can eat away at your profit. We’ve seen people have to sell their buildings because the numbers just don’t work after extensive construction costs.

Focus on curb appeal to add value. Paint, change the carpets, update the faucets, bring in landscaping, add a sign, etc. All of those things add value but are minimal risk on the construction side. 

You need to understand the construction needed to pay market rents. Can your tenant pool absorb the increase in rent? To get $20/foot, you may have to improve your building. But you need to budget for those changes and have extra money just in case. You want to account for all of these costs so your numbers still work. 

What is the difference between capital improvement and tenant improvement? 

A typical capital improvement cost refers to the cost of a landlord improving the building. A tenant improvement allowance is money the landlord would give the tenant to improve their space. As a buyer, you want to have tenant improvement allowances in your budget. It’s a one-time capital cost to help get tenants in and improve their space. 

Criteria #5: Understand the vacancy within the market that you’re operating in 

One of the biggest things people overlook is your market’s vacancy rate for your intended asset class. For example, Edmonton has an attractive cap rate of 6-10%. But Edmonton’s vacancy rate is high. In Nanaimo, the cap rates are lower but that’s because there is high demand and low vacancy. Meaning if I have to re-tenant, my property won’t be sitting empty for months.

Putting all the criteria together, how would this strategy for investing in commercial real estate play out? 

Let’s say I buy a building for $1 million and a 65% loan to value, meaning the bank will give me $650,000. I have to come up with $350,000 plus closing costs, capital expenditures, etc. My building tenants are currently paying $10/square foot on month-to-month leases and it’s a 5% cap rate market.

If we fast forward a year, I have re-tenanted the property at $20/foot. I am now going to get the property reappraised at the same 5% cap rate, doubling the value. I’m going to give my appraisal to a broker who will shop it around to new lenders. That will allow me to extract 100% of my original cost within 1-2 years while still owning the asset because the rents have doubled. 

The new income supports a higher debt level, allowing me to refinance, pay out my previous mortgage, and put that money back in my pocket for my next property. 

With this strategy, you can get 80-105% of the original investment out and still own the asset at the same debt level but a much better interest rate. 

Is there an asset class this strategy works best for? 

It typically works better in industrial real estate rather than retail. Industrial is very limited on the landlord side; you don’t have to invest as much in the building once you hand over the keys. Whereas the retail side may see more challenges, more tenant improvement costs, more construction, etc. Retail is more landlord-intensive. 

Office is probably the second best asset class for this strategy. I’d stay away from retail unless there’s a huge gap between current rents being paid and market rents.

How much money do you need to execute this strategy?

Typically this strategy is done by syndicates, partnerships, friends and family in a corporation, etc. You’re usually buying in the 65% loan to value region. So run those numbers when you’re looking at these buildings. This isn’t something you can do with 10-15% down. You need to plan for at least 35% down plus closing and construction costs. 

Closing costs include property transfer tax, unless you buy the shares that own the building. That way the name on title doesn’t change just who owns the company. You’ll also need to pay for your appraisals, environmental, inspection, legal costs, lender’s legal costs, consultants you might hire, lending fee, mortgage broker fee, etc. 

You’ll want to put all of those costs into a pro forma to make sure they check out. There are a lot more costs that go into this than there would be if you were just buying a residential condo. 

A word of caution about this strategy: 

Before you attempt this strategy, you need to consult a professional or team of professionals in the industry. There are lots of opportunities to be part of syndications if you want to watch this happen and see how the metrics work. 

It’s not as easy as it sounds. You need to have some great experience or great people around you.

The 6 Pack: Getting to Know Founder and Managing Director of William Wright Commercial (and VCREP host!), Cory Wright 

Favourite bar or restaurant

I really like Cardero’s. It’s consistent food and not overpriced. Anything by DoorDash also works for me! 

What would be your last meal on death row?

I’m going to go with a huge, meat lovers pizza, neapolitan style. And I’ll follow it with Ben & Jerry’s ice cream, their churro flavour.

We’re skipping this question because we all know Cory’s favourite band…it’s Nickelback! 

What is your go-to karaoke song?

Probably Photograph by Nickelback. Or Fast Car by Tacy Chapman. I’d be horrible at it but I hope everyone else has had as many drinks as I have by the time I start singing.

Share a book recommendation.

I’m going to go with Good to Great by Jim Collins. It’s about his business philosophy and the flywheel. I would also recommend Never Split the Difference by Christopher Voss for any realtors out there. It’s all about negotiating. 

What is something you’ve purchased recently for under $1500 that has had a positive impact on your life? 

My left Peloton pedal. I broke the original one, replaced it and can now ride my bike again. I ride my Peloton every morning so my pants fit! If I don’t ride it, the Ben & Jerry’s will catch up to me.