Investing in Commercial Buildings

Erik Doyle and Dave Hulshof
 
Sarah: Dave as well from Elevation with a background in Wealth Management. Dave's role at Elevation is mainly around analyzing multi-residential properties, commercial buildings and seeking off market opportunities. So tonight, Investing in Commercial Buildings, the difference between buying a building and investing in other properties, top things to consider, due diligence, overview and some financial options. So welcome guys, take it away.

Dave: Thank you. Appreciate it. And maybe a virtual round of applause for Ryan for fighting for landlord rights.

Erik: Now, that was amazing when I heard he was doing that.

Dave: What we thought we would do today is just a little bit different. Probably we're going to run it like a Q and A. I'm going to fire a question at Erik from the perspective of a first time home buyer. Actually, first I'm building buyers, a little background on myself. I come from the private wealth space as Sarah had indicated. Really what one of my goals this year is to actually purchase a building and that's where we get to. What we're going to do is take the vision of first I'm doing it, and I'm going to run through with Erik and hopefully answer as many questions for first-time building owners. Erik?

Erik: Perfect. Take it away. What do you want to know? Since you are actually looking for an apartment building this year. You are kind of the ideal client.

Dave: Maybe you could tell us a bit about yourself for the people just to get to know you.

Erik: Amazing. I always love when Sarah brings up that flea infested story, because it's like the worst story I've ever had in real estate. It cost me a little like 10 grand just in straight carrying costs. I've been a real estate investor before I started out with Rich Dad, Poor Dad, as I'm sure the vast majority of people here got the real estate bug. Met Dylan Suitor had Stefan Aarnio his class up in Winnipeg. And he got me to come on the team and ever since then, I've been very fast paced learning, very fast paced, helping clients expand in real estate. And I love every second.

Dave: Yeah, it's definitely fast paced. We love it. Let's start maybe with the basics. How is buying a building different from buying a residential home?

Erik: Amazing. Once you start getting into buildings the valuation changes. Yes technically a 15 unit apartment building, just for an example is the same thing as a duplex. It just has more tenants. There are different building systems that are involved, so it's just a bigger scale. Duplex will say the main difference is that you have to start using cap rates in terms of values. If you have a duplex that's on the Hamilton mountain, a duplex right down the street, all the Hamilton mountain, you can use that as a comparable, once you start getting into 10, 15, 20, 50 unit buildings, there are not really any comparables for that property. Potential even in that city, like it might be the only building in the city, depending where we are.

That's when you have to start using copper rates to value different properties, and that is based on the income versus the expenses. Your net operating income divided by the cap rate will give you the value. The triangle, unfortunately we can't bring it up on the screen, but the triangle. Yes, if you ever want to Google the copper triangle or something like that, it's a very easy way. If you're missing one piece to find the other piece. If you see a property that's selling at $2 million and the general cap rate for that for that value of building or for that, those finishes in the building, the finishes in the building is 5%, then that will give you what they are selling or what the net operating income is for that building.

Dave: If you guys on the chat, haven't seen it. Ryan touched on due diligence, but perhaps you can give us a little bit of overview on some things to think about when you are looking and perhaps how it differs?

Erik: As you can imagine, once you start getting into large buildings, the due diligence process is extremely in-depth for a duplex. You might be able to buy that with no conditions especially if it's like turnkey. When you start getting into buildings, there's a ton more to evaluate. You need to compare or confirm that all the rents are what they are. If there's 15 leases, you need to see all 15 leases to make sure that's actually the income of the building.

There can also be property management contracts. There can be boiler contracts. There could be hot water contracts, so there's a ton more, there could be lawn care. There could be snow care. So there's a ton more contracts to validate to make sure you are still getting the deal that you originally thought you were.

Dave: I saw one of the questions come up. How's the cap rate affected by building conditions and how has your cap rate even come to?

Erik: Sure, a cap rate is based on three factors. That's what each city has. It has a certain cap based on the infrastructure in the city and the potential growth in the city. Say a building was extremely rundown. It doesn't have no much income. It might be selling at a seven cap. When you refinance as a turnkey building, the best cap rate for that town might be for the city. It might be four and a half. The difference in value between the 7% cap and a four and a half cap is gigantic.

Dave: Maybe explain a little bit more on cap rate with respect to its return on investment.

Erik: Sure I'm gonna have to pull up my calculator. I wasn't prepared with the number.

Dave: Too hard here? Here's the triangle here. That's helpful.

Erik: Say for instance, you increase the income of the building by $5,000, the total income. That could be a hundred dollars per unit. That could be a turn over one unit and now you're increasing the rent for that unit. If you increase the capital or if you increase the income by 5,000 at a 4% cap rate, you have now increased your building value, 125 grand. All you've done is increase your income by 5,000 and your building value at a 4% cap rate is 125 grand and that's 5,000 for the year and that's 5,000 for the year.
You can see the great power in increasing this building. If you find an undervalued property and you can double the income, you almost double the value.

Dave: That's why in some cases you'll see that Castro key strategy. In some cases they go as high as, even go to 10,000 to pay them to get out because the lift on that is going to be 150,000-200,000 things like that.

Erik: It can definitely be very worth it. Cause if you just pay 10,000, but you're increasing income by 20,000, you're now putting 250 grand in value in your pocket. So 20 grand for 250, I'm pretty sure investors will trade that all day.

Dave: Yeah, absolutely agreed. And that kind of ties into the analysis portion. And one of the things from my background before I was very heavy on the private wealth side and in analysis and truly understanding it and coming over here a big reason for joining the team is it's very heavy in the analytics and understanding that. Maybe you could chat with us about some of the things that we do on the analysis side.

Erik: When you look for a residential duplex, you're not really breaking into these. You potentially might be if you're doing some sort of borough project, but if you're just looking at the listing, you see a vacant duplex, it what it's what it is when you actually go into apartment buildings and then you need to do calculations for values.

It starts bringing up post rental prices. And then after rental prices, how much it's going to take to make one. There's three to four spreadsheets that you have to look at and analyze for every single building. It's very in-depth and it's a lot more spreadsheets than just like a regular residential property.

Dave: That helps to build out the long term strategy. Is it worth doing a strategy this way or this way, and then a long-term strategy? Maybe you can chat with us about CMHC and how that might be involved?

Erik: Generally an idea for us to get these properties is to find something that's undervalued and you might have to get conventional financing depending how bad it is. You might have to get private financing and then fix up the property, which could be a gigantic budget because now we're doing real estate. You might be putting 300 million dollars depending on the size. After that, we go to CMHC financing. Since the building is now completely turnkey and that gives the best rates. The potential for keeping 15% of the property. 85% loan to values there a 40 year amortization has a potential.

It really just depends on the building and their criteria. You may see a coverage or debt coverage ratio to, or coverage ratio, of 1.2 or higher. And that's what qualifies for CMHC. For every a hundred dollars you spend on the building, you're getting 120 back

Dave: Beat me to it. I was going to ask you to explain the difference.

Erik: I already saw the question coming.

Dave: But that's good to understand, right? It's good to understand that long-term vision and work towards getting that CMHC certificate. And when you show up to the banks, that's where you can start to get some of these advantageous rates and long-term amortizations because we start to run the numbers and we amortize it out 35 years. It's going to make a big difference.

Erik: Commercial real estate, or I guess see me, she is now doing commercial lending. Just like you would get on, if you didn't have 20% down on your primary residence or a single family home, you might be able to put 5% to 10% down. They are now doing that for apartment buildings because they're seeing this as recession proof.

It's as close as you can get a safe bet in real estate. They're very comfortable just putting an insurance premium down there. Giving you extremely preferred rates like between conventional and CMHC, approximately doubles the cash flow. If you are looking for a cash flow positive building, then you almost always want to go to CMHC, unless there's some circumstance of why you don't want to go there.

Dave: That's a positive CMHC want not to knock them, but what would be some of the negatives?

Erik: You will not, sensor is only an 85% loan to value you won't build equity as fast. If you are paying your mortgage down in 25 years, obviously you're going to pay more principal down than if you're paying a mortgage down to 40 years. Your cash flow will be much higher, but the actual principal pay down will be lower. So if you want your building paid off in 25, that's a, kind of Secondly, for CMHC, when you refinance those buildings, there's only two or three ways you can do it.

One, you can only refinance for three reasons. So one, you can only bring into improvements for the building that is currently on. But if you just made it a turnkey building, you most likely won't need to do that for a bunch of years. If you can just refinance, you need to buy another building with it. With regular commercial financing, you can refinance, you'll have 200 grand hit your bank account, and then you can go to Remuda if you want. For CMHC, you have to put it back into the Canadian economy. And that's the only stipulation that they do for the refinance.

Dave: And last perhaps just turn around times.

Erik: And turn off turnaround time. My goodness. Since it is an amazing product. But since it is government run I'm sure you are all aware. It takes quite some time. Regular commercial financing can take a month to a couple of weeks, depending on how fast you think. After the due diligence process, it might be a month or two total CMHC going directly there, I think the recent one we did was five to six months. And the whole time you don't actually know whether they approve of you or not.

You apply and then you might not hear from them for 3 months. And then they'll have all of a sudden, they'll have a letter of intent and then you move forward. But that whole process is a six month long process. you would have to either own the building, do a BRRRR for the apartment building, or you would have to go find a deal that you can actually put a six month closing off.

Dave: Ryan talked about it too, right? Like you got to have people that do this day in, day out on the lawyer side. They need to be involved in investing in real estate the same as us. It's just too complex, right? From real estate, you need the agents that do this, understand it. That's a good example. Understanding timeframes and setting expectations on both sides and negotiating, it's critical.

Erik: If you ask her like a regular mortgage broker to go to CMHC commercial financing, they're going to stare at you like deer in the headlights. Especially for that, just because it's such a long timeframe and so complicated. And so you have to finesse it a bit. I always work with a CMHC expert.

Dave: One of the questions is, do you get the CMHC financing from a bank or mortgage broker?

Erik: It would be a mortgage broker for me. I always work with David Mortgage Alliance. He's on the Sudana trucks team. He is our go-to CMC expert for getting these deals done. I've had no issues with them recently. And we're financing CMHC deals. I'm quite a fan of him whereas other mortgage brokers I worked with in the past do not know the ins and outs of getting CMHC and they might just go direct to commercial financing and that might actually make the building like negative cash flow.

Dave: We actually have an instance right now where an individual wants to use their friend. Totally understand. We did caution for these exact reasons, just making sure that the person is an expert, they weren't and at the last minute it's falling through and now we're going to have to redo. And David actually is the one running point now, and he's going to have to come up with some creative financing solutions to get it solved. And that's a good example. The person had good intentions, but unfortunately they're not the expert in that type of financing, especially on the commercial side for CMHC.

Erik: Friends of family can be very difficult. Just because it feels like you want to use them just because you're a friend, your family, but if you are building a real estate investing business that you want to scale, you have to go to the experts.

Dave: Completely agree. So in a circumstance like this, how does someone get started on their first building? Like how do we get in?

Erik: I got started on the first building. The first step would, would be either having a sit down with myself or a mortgage broker that understands this type of deal that understands if you have the potential to move up, you might be have one to four properties and looking to scale to four or five, six, and it's generally going to be very tough to get into apartment buildings as your first property in less you own a business and have a gigantic income. Just because the amount of equity you can get from properties over time, which is the whole reason we're investing as real estate investors, is that you can put that equity that you have into a different building, which will give you different cash flow in different financing options.

Dave: Last question for us and we can wrap it up, but what can people expect coming to work for if they want to work with you and the Elevation Team?

Erik: What can people expect? That's a fantastic question.

Dave: Thank you. I just came up with it.

Erik: I know, people can expect that we're going to bring them along every step of the way. We are building relationships with our clients. We're not just a. A transactional team. We do like building and helping people develop into greater investors over time. Whether their first property or they're ready for a fourplex, fiveplex, 20 Plex or anything like that, we can definitely help them get into that and hold their hand all along the way.
We don't really charge for coaching at all. We just give that away as a free service. To, to our clients and we just walk them through every step of the process, whether that's a property manager they need, or, raw real estate lawyer, you have Ryan Carson for, but any one of your power team that you're actually missing since we are real estate investors ourselves, we can just plug you right into that system and give you a white glove service.

Dave: It seems every time we talk. You guys, us even Ryan, the experts are really just saying have that power team. And we've done a good job of building that vetting out that power team. Obviously we're happy to take out somebody that's in that power team in subbing to somebody they may have, but we've got it.

And the last plug for us is we're doing. With off-market opportunities. And that's one of the things that I'm doing and bringing to the team is understanding and finding those off-market properties, analyzing them and bringing them to the table. So we've got a lot of, and that seems to be the big push these days is off market. And they're not always off market, but there's a, we're getting a lot of lift on that and finding them. We're really separating ourselves from the onboarding process. We're all real estate investors ourselves. We have a deep network and we're finding those unique opportunities.

Erik: That is the most important part. As Sarah always says, your network is your network. Absolutely a nice quote from Sarah. But that is by far the most important thing. Just to have a team around you that knows what they're doing because I have wasted a lot of money trying to develop a team on my own where it is just very easy to plug into a team that already knows what they're doing and can already take you to where they want to go.

Dave: We'll see it a lot of times people will be looking for a property and we'll see what it sells for. And, that'll be the upside on an after repair value and they're purchasing it today and you're thinking, wow that's unfortunate. Unless they're seeing something we're not, they're just completely overpaying. And a lot of times it's, they don't have good counsel. They don't have good people in their corner that are advising that, Hey, perhaps this is a time to hit the brakes.

Erik: That's what Ryan was going back to as well as when it starts failing. And now they suddenly have a hundred grand in cash bills that they have to bring up. That goes back to its previous one.

Dave: Sarah, you better cut us off because we'll start talking the  whole night.

Sarah: I don't want to interrupt but that was awesome. Great presentation guys in the, I agree with you, right? Your power team is going to do everything in order to ensure that scaling you reach your goals, because if you don't have the right team and you aren't going to go very far.
And I won't say I know that the Windrose group, one of our partners as well, Claire and a few members of her team are there too. And then they've done tons of CMHC deals, but yes, absolutely. A hundred percent you need to have a right core team of investors, ideally themselves as well.
And oftentimes they're going to be working together on many other deals. They're going to have the ability to communicate and get things done so quickly for you. Like you said, when I get a deal, often it's actually with Elevation in you just even being able to connect everybody and be like, here's the deal taking go.

You just basically have them do everything in the background. You guys included that's all, what it's about is delegate, delegate, work on the business not in the business. Dave, Erik, thank you so much. I know there were a few questions there.