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.
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.
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.
- 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.
- 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):
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.
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.