Distressed Property – Buy Or Forego?

I have previously mentioned that I’m in the midst of doing DD on a distressed commercial property, with a view of investing. (Track Record Of Dividends From 2012)

After assessing the merits of the situation, I’ve somewhat reluctantly, decided to forgo this opportunity. Let me share the details, and perhaps someone more well versed in property investing can share insights. Afterall, I’ve always maintained that this is not my forte.

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The property in question, is a freehold, ground floor shophouse with an attached 2nd floor residential unit. The property is situated in the heartlands, in a built up area within the town centre, with good foot traffic. It has been rented out to an eye care / spectacles business, which in turn sublets the residential unit above. The owner currently only deals with the business owner.

The asking price of the property is $2.3mil, but in my DD, I realised I can bypass the agents and deal directly with the owner. Although I haven’t gotten to the stage of negotiating prices, I’m fairly confident of getting it for $1.9mil – $1.95mil.

There’s no valuation done as yet, but a like for like comparison amongst similar units indicates that the asking price psf is very reasonable. The price is distorted somewhat, by the fact that it includes a residential unit above. Residential unit prices on a psf basis, is generally much lower than commericial units.

So what’s so special about this?

What got my attention as a deep value investor, is the story behind the situation. The current owner just inherited the said property for <1 year from his father. After inheriting the property (amongst other things), the current owner quit his job as an odd job laborer (is there such a thing as quitting a job as an odd job laborer?!), and got addicted to gambling.

The property is pledged to UOB for bank loans for gambling, and currently the debt repayment is already a few months past due.

So yes, it’s fair to say we’re talking about a distressed asset here.

More details: The property is currently rented out to the business for $7,200/mth, I am not sure how much the owner in turn collects from the tenants of the residential unit above. He is unlikely to reveal that info to me.

The $7,200 rent has been kept constant for at least the past 8 years.

The investment merits:

Knowing the owner directly, my pitch to him is that we can bypass the agents and the bank (which is in the midst of possessing the property and would likely put it up for auction), save on all the transaction fees, including the expensive auction fees, and deal directly.

Also, I appealed to the gambler side of the owner by saying that once the deal is signed and closed, he’d receive the full sum of $$$ from me directly, instead of having a large chunk being taken up by UOB for his outstanding loans, who’d take their cut, as well as any related fees from the sale of the property (Which is likely to be substantial), before disbursing whatever’s left to him.

He is free to use this money to pay back the loans…….. but in all likelihood he’ll use it for gambling, paying back the bare minimum (loan instalments)  to the bank. Telling a gambler that he’d get more funds to gamble, is akin to telling a drug addict that you don’t really need to go cold turkey.

It’s just so much more palatable.

At this stage, please don’t be critical of me. I don’t agree with gambling and any related irresponsible behavior. But hey, I’m not responsible for others. This world will always have people from all walks of life. As an investor, all I am looking out for is to capitalize on situations.

I don’t create these situations, I capitalize on them. Yes, some people will eventually get burnt. But that’s of their own creation.

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Let’s crunch some numbers.

Assuming I pay $1.9mil in cold hard cash, and assuming I maintain the rent at $7,200 (A rate at which the business owner has already indicated he’d be very happy to extend the lease), the math should be easy to work out.

Since I am dealing directly with the owner, I’ll be getting a yield of:

(7,200 x 12) / 1,900,000 x100% = 4.55%

That’s not too bad a yield, but not fantastic either. Anyone faced with such a situation, and having decided to plonk down $1.9mil in cash, would only be able to justify it if he’s banking on capital appreciation. That means his investing thesis mainly revolves around the fact that the purchase price is deemed to be substantially below fair value.


Now what if there’s room for rental reversion? (A complex term which basically just means raising rent)

There are 2 reasons why I think the rent is greatly depressed.

  1. The rent has been constant for 8 years. The old man owning it before, was simply content to receive the rent without negotiation. His son, was presumably busy spending it.
  2. Although I have no contact with the sub tenants leasing the residential unit, it is possible to split up the commercial ground floor unit and the residential unit and rent out to 2 different tenants. I noted that the entrance to the residential unit above is a separate entrance from the commercial unit, although they are linked. Dealing with 2 tenants will likely mean I’ll be able to get a higher overall rental rate.

I’ll assume, (probably having to find new tenants), and perhaps with some minor asset enhancement, I’ll be able to raise the rent to $8,250 (about 15% increase).

Again, let’s assume I pay $1.9mil in cold hard cash. The yield becomes:

(8,250 x 12) / 1,900,000 x 100% = 5.21%

Getting paid 5.21% whilst waiting for capital appreciation is increasingly looking better, but not exactly something to be overly proud of either.


Now what if I could raise rent, and this time, I opt to take up 70% bank financing?

This means my cash outlay would be 30% x $1.9mil = $570,000

The bank loan portion would be 70% x $1.9mil = $1,330,000

Assuming a 3% commercial property loan, at a fixed rate, for a loan tenure of 25 years, and taking into account that the property is freehold, here are the details of the loan (according to DBS):

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So every month, the interest payable would be $561,958.7 / (25 x12) = $1,873

This means of the $8,250 rent, $1,873 goes to paying the interest. That leaves me with $6,377.

This $6,377 based on a cash outlay of $570,000, nets me a yield of 13.43%!

Wow. That’s not too bad at all. Of course, in reality, the cash I’ll see every month would be much less than $6,377 as some portion of it goes to paying down the actual loan, not just the interest.

However, since this actual loan is part of the property’s “equity”, it theoretically adds to MY net worth and is part of my ROI.

This means that if all things being constant, the deal is like this:

Pay $570,000 now, and I’ll receive approximately $(8,250 – 6,308) = $1,942 every month for the next 25 years, and at the end of 25 years, the unit which is supposedly worth $1.9mil, would be mine for free. Add in a sizable capital appreciation, and we got a multi year huge winner here.

That’s my thinking anyway. Sounds like a pretty good deal.

Which is why I’m reluctant to forgo this. Why then, have I decided not to go ahead?

Well, the main bugbear is that I’ve also found out in my DD, that this same owner, is still going around to illegal multiple moneylenders to borrow money, using the property deed as collateral!

OK. This changes the dynamics of all the above.

You see, the above only holds true if there’s a certain amount of predictability. With illegal moneylenders being involved, and I have absolutely no experience with how it works, I am suddenly blindsided by the myriad number of scenarios that can develop.

I don’t think URA will inform the moneylenders when the property has transacted.

I also don’t think the illegal moneylenders would be kind enough, to just leave if they approach my tenant or myself about a certain loan, if I simply tell them the previous owner is gone.

Singapore is a land of laws. I’m sure this can be sorted out eventually, but the question is, at what cost? I am suddenly not so sure if the returns is worth the effort. The returns may be attractive, but if the effort is >>>>>>>>>>> than what I am prepared to put in, it may suddenly appear to be less attractive.

Let’s not forget that there’s time and opportunity costs in any investments as well.

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Anyway, I’ll let this lead die off for a while. Perhaps, after a few rounds of unsuccessful auctions, I can approach with a ridiculous offer. Maybe $1.7mil. Afterall, I postulate that if it’s another $200,000 lower, well I can take out $100,000 and hire security guards 24/7 if need be. That’s an extreme scenario.

Anyone with prior experience in this sorta matters, pls let me know if my thoughts and calculations are correct. (Yes, I know I have not included miscellaneous stuff like cost of getting new tenants, and cost of asset enhancement. I am assuming they are insignificant)

I’ll be happy to learn from someone who has in depth knowledge of commercial property investments.

As always, happy hunting for value.

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16 comments

  1. Hi TTTI,

    I am not a property investor or I am really good at it. Just that I have been in touch for it recently due to my work and I think shophouse price psf seem to be very high as compared to other residential property.

    However, it is also important to note that “where the shophouse is located” and “If the tenant leave, will I be able to get another tenant who’s willingly to pay a good rental?”.

    I am not too sure about resale of shophouse, but I did hear before its not easy to sell them off.

    Just my 2 cents worth.

    Regards,
    TUB

    Like

    1. Hi TUB
      Thanks for your comment.
      Yea, the price psf is much higher than that of residential property, I guess it’s cos the rent psf is also higher than what you can get for residential.
      Like you said, getting another tenant is the big question mark if the current tenant leaves. If I stick to the current rent, the current tenant is more than happy to stay, but I am not so sure what happens if the rent is raised.

      Like

  2. Hi TTI,

    I will avoid purchasing the property. Honestly, it is not worth the hassle when it comes to illegal moneylenders. Peace of mind has no price to it. And who knows, you may only be scratching the surface with the results of your dd.

    Like

  3. Hi TTI, i forward this to some of my friends who would rather invest in property to see how you look at it from a holistic investment perspective.
    I love the sequence you presented it. It really shocked me of the baggage that tied to it.
    Can i say that for commercial, there will be much less expense and its more like a triple net lease? The ROA yield looks good at 4-5%.
    I wrote this to my friend and hope that you don’t mind me pasting here:
    the permutations seem good that it’s a freehold and may have potential to be sold to redeveloper for higher value.
    As a commercial property, with less expenses it is also cleaner for am investor like myself.
    The net property income yield of 4 to 5% looks low by REIT standard but is unleveraged and versus the cap rate of commercial REITs of 3.75% it looks high.
    You could leveraged more.
    You got to make sure that the demand for this property is there if you are leveraging. Your 25 year mortgage is 6.2k per month. Some of your cash flow might need to standby for this.
    I can’t imagine the shop staying for 25 years haha so that’s a risk there.
    I also like that the cash on cash yield is 4.2%.this is pure cash flow yield.
    In this case the total return we are looking at is perhaps a 4% fcf yield ± 3-5% growth.

    Like

    1. Hi Kyith
      I don’t have much experience with REITs, is the cap rate for commercial ones usually 3.75% or so?
      I read your recent article about REITs, so I guess you have done some homework on this.
      (I did do some research on REITs in relation to my latest target – the company is not a REIT but I had to research a bit to compare)

      lol yes I don’t think the shophouse will be around for 25 years… although the owner (the father who passed it to the gambler) supposedly held it for decades, living off it’s rent into his old age until he passed.
      I extrapolated for 25 years because that’s the max loan tenure that DBS would extend to me for the FH commercial property. Of course, there’d be many variables and it’s hard to predict. Interest rates alone would be a huge factor.

      I sat up and noticed as I think I can revert the rent substantially, and I think there is capital appreciation too in a few years.

      There isn’t much expenses that I can think of. The tenants take care of all the utilities and related fees. Probably the only expense is depreciation of the assets and furniture etc.

      Do post and let us know if your friends who are property investors (?) have any insights. Or if they have insights on what would illegal loansharks do in this scenario if the property deed that they thought is valid, has actually changed hands to a new owner.

      Or if any illegal loansharks reading this would be kind enough to elucidate, that’d be appreciated. HAHA!

      Like

      1. hi TTI,

        I think the CAP rates are around there. what i am using is the lowest grade office reit, fcot. I will ask some of my property agent friends to see if i can value add a bit here.

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  4. I think you will be lying to the seller if you said “he’d receive the full sum of $$$ from me directly”. Do you think he can get the money and continue to pay UOB installments? Before the title deed change hands, UOB have to release it, the loan must be fully redeemed/repaid.

    Which begs the question, how familiar are you with property transactions?

    Like

  5. Hi TTTI,

    I am more of a property investor than shares investor. My property portfolio include a retail space in the downtown of Singapore.

    If the current owner is not a company, you do not have to pay GST for the transaction. If the seller is under a company, you need to add in 7% GST as cost. However, there are ways to get back the GST from IRAS, in case you are buying it, I can share with you how to do it. But I do not think the seller is a company, as this practice is less common in the old days.

    Property values are less efficient as compared to shares (and this is the reason I love property over shares) And that would make it easy to obtain good MOS. Additionally, with the condition it comes with, you have a good bargaining power. If affordability is not a constrain and you have a long term view, this looks like a good deal IMO. Having said that, I do not know the location, and sq ft, but just based on the fact that is a freehold, and two storey building. I like two storey shop houses where you can lease to two tenants, reducing the risk of fully vacant and cease cash flow. I saw one in old upper Thomson in mid 2000, and was selling at 1 million during those time (with small foot traffic, because it is meant to serve the private estate surrounding it), so this appears interesting to me. I would not mind to check out this investment if you need further thoughts.

    Opportunity does not knock on our door everyday. However, having said that, the main focus is to determine if this is an opportunity (provided affordability is not an concern even if worst scenario happens) or “fraud”. If the owner has too much request not to do things normally and legally, I rather miss it. As for the loan shark, it just gives me a better opportunity to negotiate more with the seller.

    Hope I did not confuse you, but offer my 2 cent worth. And having shared my view, please do your due diligence. Good luck

    Like

  6. Hi TTTI,

    Just saw your last reply after I posted mine. Yes, another way is taking over the company which owns the property, and saves you not only the GST, but stamp duty, cheaper legal fees. However, I am not sure if you can take a bank loan or not.

    However, due to the complexity of the status of the owner, I would prefer a clean cut, that is not buying the company, but just the property. The GST can be claimed back if you buy it in a company name. This can be easily done, unless the system has changed lately.

    If you still want to buy the owners’ company to take over the property, I suggest you to seek advise from your lawyer, accountant, to make sure the company accounts and obligations are “clean”. This is the messy part of the transaction, which I will avoid if I were you.

    Good luck.

    Like

    1. Hi millionfaith
      Ahh you raised many good and enlightening points. I have not checked with the bank if the loan is extendable if it’s via a corporate structure.
      Just to clarify a quick point, if it is buying the property FROM the company, there will be GST incurred, but you say there’s a way to claim it back. I assume you mean by incorporating my own company (which I already have btw) and getting it GST registered, and then claiming the GST on expenses that the company has incurred right?
      It is not really a direct reimbursement per say as the company still has to incur adequate expenses.
      Many permutations indeed.
      I’ll have to give it much thought.
      I am glad to hear that you, as a seasoned property investor, seem to think favorably of this deal.

      Like

  7. Hi TTI,

    You are right. If the property is sold via a company, the transaction requires you, or your company to pay 7% GST. If the transaction is via a GST registered company (i.e your company), you can claim it back (within 3 to 6 months). Having said that, your company, going forward would then need to file GST returns, in my case, every 6 months. This is because your company will charge GST, i.e. your tenant’s rent is charged 7% GST, and whatever the company paid on GST, will be offset.

    Before you go with this route of purchase, please speak to an accountant to make sure your company meets all the criteria required by IRAS, although these criteria are quite standard.

    I believe banks would not grant a loan though, so this may be a big obstacle to cross.

    All the best.

    Like

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