There is a general notion that in order to buy a commercial property, you have to be a very wealthy person, while more modest means will suffice to buy a residential property. While in general this may be true, we have already seen in Chapter 8 that it is possible to buy a viable commercial property for $59,000 that has all the advantages of any commercial prop- erty. So long as people think that commercial properties are ex- pensive, then you will have little competition looking at small (low capital value) commercial buildings.
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To the extent that it is true that commercial properties are generally more expensive than residential properties, there is a commensurate benefit. To own $10 million worth of residential property, you generally would have to own a lot of separate properties, with many dozens of separate rental agreements. The management overheads could be huge! A single commer- cial property, on the other hand, could be worth the same $10 million. You may have only one lease document, and therefore much reduced management concerns.
Since there are so many people in the market for a residential property, and since the capital values involved tend to be much smaller, it will be much more difficult to find a residential property selling for less than 10 percent of its replacement cost than a commercial property at such a discount.
Let me give you an example. In the mid-1990s I was in- volved in a bid on a building in downtown Dallas, Texas, known as the Republic Tower. It actually comprised three tow- ers of fifty floors, thirty-three floors, and eight floors respec- tively. When the first tower was built, it was the tallest building west of the Mississippi. The revolving searchlight on top could be seen at night for many miles. The buildings comprised a massive 1.92 million square feet of rentable space. The cost to replace the buildings was around $300 million. What would you have offered for these buildings?
My consortium’s offer was in fact for $15 million. That is not a typo! We were offering around 5 percent of the cost of re- placing the buildings.
Now at this stage I should give you a few more details. Commercial buildings are generally valued on the basis of their rental income. The Republic Tower back then was only around 6 percent leased. In fact, the total rental income did not cover the operating expenses: There was a shortfall of $1.6 million. Based on a capitalization rate of around 10 percent for office RESIDENTIAL VERSUSCOMMERCIALPROPERTY 161 ccc-deRoos_ch14_151-168.qxd 9/17/04 12:41 PM Page 161
space, that would have put a value on the property of negative $16 million.
On the other hand, with market rentals of around $20 per square foot (per annum), the building had a potential rental income of nearly $40 million per year (1.92 million square feet times $20 per square foot). At that same capital- ization rate of 10 percent, that would give it a value of almost $400 million.
Now for a number of reasons, our bid was not successful. In case you are thinking: “I should think not! I don’t want to hear of anyone buying well over $300 million worth of prop- erty for $15 million in one fell swoop,” then take heart. In De- cember of 1997, the property was reportedly sold to a partnership involving Credit Suisse First Boston for the princely sum of $25 million. They are now spending $75 mil- lion completely refurbishing the property (including, for in- stance, replacing all of the 8,000 panes of glass with dual-pane, energy-efficient reflective glass). But even so, it is a great deal, and a testament to my strategy that you can find properties that are selling for a fraction of their real value, if only you are willing to look for the extraordinary, for proper- ties with a twist, for properties where by changing something around, you can reap huge benefits.
Another deal I was involved with concerned a massive single- story building in the Sydney suburb of Yennora. Known as the Sydney Wool Exchange, this building comprised a vast three million square feet of warehouse space. It was believed to be the largest building in the Southern Hemisphere, and it took quite some time just to drive around the perimeter. The wool clipped from some 20 million Australian sheep would pass through its storage facilities. The building was built for the gov- ernment, owned by the government, and leased to the govern- ment. And now, the government had decided it was time to sell. 162 REAL ESTATE RICHES
Since the rental income was $7.9 million, and since capital- ization rates were around 11 percent, it was determined through initial negotiations that a sale might be effected at around $72 million.
On the face of it, a return of 11 percent would not get me excited at all. However, there were some extenuating circumstances.
First, by only considering the capitalized income, you are completely overlooking the fact that the three-million- square-foot building was sitting on seven million square feet of land. The government had not taken the land value into account, probably on the basis that it was not generating any income anyway. The surplus land was worth some $16 mil- lion, however.
Second and far more important, the government, as we have noted, was leasing this building to themselves. In other words it was money out of one pocket and into another. They had no vested interest in getting a market rental for the build- ing, as it would not benefit them anyway. The average rental of some $2.63 per square foot was nowhere near market rentals. The large, national tenant in the building next door was paying $5.60 per square foot, more than double.
We commissioned an appraisal, which came in at over $140 million. In the end, we were outbid by a consortium from Hong Kong, who bid $2 million more than we did, but they still got it at effectively half price. The point is, these deals exist! In this case there was over $60 million to be made after costs.
In mentioning these examples, I am not trying to impress you with big numbers, but rather trying to impress upon you that great deals happen all the time, from little $22,500 cot- tages and $59,000 commercial buildings, right through to com- mercial properties worth many hundreds of millions of dollars. And by the way, the effort involved in buying a $1 million RESIDENTIAL VERSUSCOMMERCIALPROPERTY 163 ccc-deRoos_ch14_151-168.qxd 9/17/04 12:41 PM Page 163
building is about the same as the effort involved in buying a $100 million building. Would you rather do a $100 million deal once, or a $1 million deal 100 times?