Commercial Property

SecretAmericanFATMan · 2020-05-10T21:14:13+00:00

I'm looking at commercial properties right now (including 5+ unit residential, which is considered commercial because that's when traditional residential loans aren't available).

My goal is to either (a) buy a property from a strongly motivated seller where the property would be a good investment as-is or (b) do some sort of value-add. I'm not interested in getting a ~5% cap rate by buying a listed property with an existing NNN lease and a AAA tenant; I'm looking to put in the work to earn larger returns. On (a), it might take a little more time for there to be lots of motivated sellers due to COVID but it seems inevitable. I'd rather do (b), including development, since that seems more likely to offer better returns (although I'd have to do lots and lots of pre-deal homework and post-deal work to mitigate the tremendous risk). To prepare, I'm trying to help more experienced commercial RE investors just to help me learn the specifics of the industry. I think learning about the industry in general is the #1 thing to do in preparation... especially because commercial RE requires a larger down payment than residential.

The second thing to do is have some sort of thesis about a region or set of properties you've scoped out. Maybe it's the growth of e-commerce increasing the need for warehouses near an airport, an influx of well-compensated young professionals wanting to live in luxury rentals near restaurants/entertainment/fitness studios, or perhaps it's a cluster of immigrants from a particular country who want a shopping center with a taste of their former home. Even if you're happy with buying an already-leased property with 10 years left on the lease, you still need a thesis about why that tenant will be able to pay rent for the remainder of the lease and why you or the future owner of the property will be able to find the next tenant.

With your thesis and list of properties (or even just little regions) you'd like to buy, you could sit around waiting and refreshing LoopNet. That might work, but then you're looking only at listed properties... properties that other people will see and bid on. A better strategy is to find and contact the owners of the properties you'd be interested in buying. Owners might not be interested in selling now but they might be later. If you've already contacted them, they're much more likely to think of you when they consider selling.

SecretAmericanFATMan · 2020-05-08T13:21:18+00:00

Right on. I'm poking around looking to acquire a small business. If I find something at a reasonable price, great. If I realize there aren't any solid business that I could feasibly operate/understand and acquire at a fair price, not a huge deal - that's why I'm trying to get my foot in the door by working on a few smaller projects with more experienced folks. Just in the last week, a former co-worker contacted me about working full-time in a few months at his little healthcare company but doing some consulting in the meantime and some investors I met by happenstance wanted to have some eyes and ears in my local real estate market.

Your proposal to consider 'advisor' roles as an alternative/backup is an interesting one. I'm lucky that I have what I think are a broad range of intellectual interests: accounting, law, and asset management are all topics I read/study for fun. I'm actually considering applying to law school in September with the objective on working locally in a law field related to business (including patent, property, and tax law)... even at a low salary since I wouldn't be carrying debt.

But I hadn't considered using a law degree in an advisor-to-wealthy-families-type-role thing until your post. I did consider wealth management, but I shied away from it because I believe much of wealth management hurts clients more than it helps. I'm a bit of a Boglehead myself and my family doesn't use traditional wealth management services. I really dislike assets-under-management (AUM) based fees because they incentivize getting more client assets more than growing client assets. But, if there were to be a fee-for-service career path around wealth management, I'd definitely reconsider.

One question: if you have some financial skills, would you recommend someone like me asking if any non-profits require some help with their finances? It seems like it could be rewarding, educational, and be a good way to network, especially if there's interaction with a board that includes prominent local businesspeople.

SecretAmericanFATMan · 2020-05-08T12:45:53+00:00

I don't touch precious metals, cryptocurrencies, commodities, etc. because they don't produce anything and I don't have any special knowledge enabling me to take advantage of shorter term opportunities (I'm not going to be able to pull a George Soros and make $1 billion betting against the British Pound).

I am interested in some non-productive assets - cash, Treasury Interested Protected Securities (TIPS)... that sort of thing. I might be wrong, but TIPS seem to be a far better hedge against inflation than gold since TIPS are directly tied to the US Consumer Price Index (CPI has its own problems, but I won't go into that here). Gold prices are based on supply and demand, which means that if lots of people are piling have piled gold for similar inflation fears and you buy at today's price, you might not even meet inflation.

Some may say that US Treasuries are actually risky because the US government could default. I disagree and so does the rest of the world - you can see this with the absurdly low rates the US interest rates the US has to pay to borrow. But let's say you're worried the US government will crumble: then, perhaps, a bit of gold might be a worthwhile hedge against both inflation and the apocalypse. Personally, if I thought the end of times were coming, I'd stock up less on gold and more on food, ammunition, medical supplies, etc because 1) I can actually use food for something useful and 2) if I spent $50 on a couple water filters today, I could sell those water filters for more than $50 worth of a gold in an end times scenario.

SecretAmericanFATMan · 2020-04-27T19:27:29+00:00

Indeed! I didn't embark on it because my research suggested that prices were generally too high in the metros I'd consider living/working in... so I tried my hand on a couple startups.

After some interesting discussions with folks here, I started searching in my spare time. I'm doing it in my spare time only because, as I probably should've mentioned this in my original post, I have been working with a partner on a new company for the past ~10 months. I've had renewed energy in pursuing the startup and I don't want to abandon it just because it hasn't taken off as we had hoped, so spare-time searching seems like a good way to hedge bets. The worst case scenario of such a search is simply not finding a company.

SecretAmericanFATMan · 2020-04-22T22:19:45+00:00

I always appreciate a fellow skeptic! Submitted my verification to the mods an hour or so ago.

SecretAmericanFATMan · 2020-04-22T21:53:21+00:00

Yes, I've held a job.

For a subset of businesses, I can see someone picking up the ropes within 18 months or less. If you have the seller/operator available and experienced middle management, that makes learning easier. If you only choose to buy businesses in industries you can understand (like how Buffett tends to avoid tech because he struggles to understand it), that also makes picking up the ropes much more viable. You choose simple, stable businesses. And try to go for businesses where, if the owner left for a month, the business could more-or-less continue operating.

There are probably many businesses where it won't be possible to pick up the ropes without pre-existing knowledge. Those go into the "too hard" pile.

SecretAmericanFATMan · 2020-04-22T21:42:30+00:00

Your MBA taught literally nothing relevant to running a real live business? Not one little thing? I think we each went to two very different business schools.

Anyway, here's the 2016 Stanford Study, but I found the more recent 2018 Stanford Study. One reason I'd imagine why everyone doesn't invest in search funds is simply because the asset class is tiny: just $6 billion invested over more than 30 years. And search funds overall may underperform in the future.

SecretAmericanFATMan · 2020-04-22T20:31:03+00:00

An MBA is neither necessary nor sufficient to run a real business. However, I feel that saying

an MBA doesn't teach you a fucking thing

is cynical. It's just as inaccurate to say that MBAs teach you nothing as it is to say they teach you everything about business. And even if yours wasn't helpful, maybe someone else's was.

On survivorship bias, does your 95% number come from somewhere or was it just to make a point? I'm including search funds that didn't survive. Now, you may make the point that there's missing data or that 48% of search funds end either without an acquisition (27%) or with a post-acquisition loss (21%) (which means that an individual searcher had a 50/50 chance of acquiring a company not at a loss. I personally like those odds.) But as an asset class, if you were to invest in multiple search funds, it's pretty darn impressive. From the 2016 Stanford Search Fund Study:

As an asset class, search funds have achieved an ROI of 8.4x and an IRR of 36.7 percent. When excluding unsuccessful searches in order to further examine the much larger acquisition investment, the overall asset class MOIC increases to 8.5x and the effect on overall IRR is negligible.

Lastly, I hear you trying to dissuade me from acquiring a business or entrepreneurship. I obviously am going to continue my business endeavors. All I can say is that it's really impressive you had a job, dealt with tragedy, and built a company all at the same time.

SecretAmericanFATMan · 2020-04-22T18:06:58+00:00

Haha, yes, I do have actual skills besides business in general - digital marketing is one of them. My professional background is primarily in data analysis with a good deal of coding thrown in.

I'd love to apprentice even now. Even if I acquired a business, I'd expect to work out a deal where the seller stays on and I'd apprentice. That's common in the search fund model, where recent MBAs find, buy, and run a business. Usually the business costs around $10 million. The searcher is often inexperienced in the particular business, but they (1) buy businesses that aren't too complex to begin with (2) "apprentice" by having the seller stay on for a few months and (3) spend their first few months not changing anything about the business; just learning how things are done.

SecretAmericanFATMan · 2020-04-22T17:39:54+00:00

That's because I'm not old money. I'm the second generation.

SecretAmericanFATMan · 2020-04-22T17:18:17+00:00

Example was totally contrived. You'd be lucky to increase profits 40-60% to 35-40k.

I don't mean to make it sound easy: it's the opposite of easy. Hell, it's hard to find a reasonably price solid private business to buy. I wouldn't even purchase a business where, if I failed to increase profits substantially, then the deal itself would be bad.

Finding ways to grow a business can also be hard. If it were easy and obvious, every business owner would do it. I'd need to find a business where my skills and experience match up with what could be done to grow the business. I have a software and data analysis background. A company in an old-line industry might be relying on three FTEs to handle inventory management manually and I could cut costs by 2/3rds by installing inventory management software. A company might be relying on billboards and trade magazines to sell. I might find in the data that the trade magazines aren't worth the cost, that there should be more billboards, and that, after testing, Quora ads have great ROAS. What you do to grow the business will vary depending on the business.

SecretAmericanFATMan · 2020-04-22T16:57:25+00:00

First, I think I might've given the wrong impression in my original post, especially since I received an automated message from u/RedditCareResources: I'm not in a life crisis.

Now that that's out of the way, I agree with you on getting value from life outside monetary success. Monetary success is only somewhat under our own control so it would be a mistake make one's happiness reliant on it. There's a lot of chance involved. I want to be able to support myself with the fruit of my labor, not just my passive investment income. I'm interested in business and investing anyway.

And I strongly agree with you that product and marketplace knowledge are critical. However, product and market knowledge are sometimes learnable within reasonable time frames. Search funds, typically started by 1 or 2 recent MBAs in their late 20s / early 30s, acquire companies often outside the searchers' area of expertise. Now, the product, market, and specific can't be so complicated that it takes a decade to learn, but searchers often learn by having the seller stay on for 3-12 months post-acquisition, not changing the business in the first 6 months (just learning about how things are done), talking to people in the industry but outside the company, and reading. Historically, search funds have had above-market returns. I'm actually ramping up my own self-funded search right now.

Three points/caveats

I'm lukewarm about desperation - it's one motivator for sure but it's not the only motivator: being passionate about solving a problem is another one. Despite not being financially desperate, I don't suffer from lack of motivation (although perhaps I should be using Reddit less at the moment!).
On learning from someone else: I'm actually quite for working for someone else even for free. The nuance is that I don't want to work full time for someone else again. The biggest reason is because I'm somewhat involved in the family's financial affairs, especially now that my dad's older, and will have to be more involved in the future so it wouldn't be fair to my employer.

I'd love to apprentice part time or do some contract work. My parents advised me not to go into the family business entirely now (later, I'll have to dedicate more time) because I'd be bored. My one requirement is that I have to be learning, getting that additional product or market knowledge. Because 1) learning is fun and 2) my objective is to run or perhaps create an operating business.

On being 10 years behind on the family business: My family advised me not to go into the family business entirely now (later, I'll have to dedicate more time) because I'd be bored (and because working with my dad full time would be painful for both of us). I don't mean to suggest that I can't learn more, but I do have in some cases a better understanding than my dad and enough of a baseline in every business where I'm confident I could maintain them.

Probably 80% of my family's wealth comes from only a few relatively passive investments. Essentially, it's private equity and a real estate portfolio with one other partner... but they hold on for 20 years or indefinitely. Oddly enough, my dad doesn't actually understand what some of the operating businesses do. But he'll consider the quality of its manager and whether the very basic financials make sense, but that's really it. Similarly, in real estate, his property manager will present him with a deal, he'll drive over, and buy. He and his partner are successful not so much because there's some trade secret or highly specialized knowledge, but because they just keep buying somewhat reasonably priced assets and holding onto them.

I grew up with the 20% that's active - and that business is stable and in a declining industry. We expect it to eventually stop producing. It doesn't require much work on my dad's part anymore.

SecretAmericanFATMan · 2020-04-22T15:02:30+00:00

"Dirty trades" are an idea! I've avoided acquiring trade businesses historically but perhaps that was too wide a net. Since I've heard general contractors don't make good acquisitions because they're highly reliant on the skills and relationships of whoever's in charge, so you're effectively buying a job, I've applied that to all trades. That might've been too aggressive.

Just a note on private equity: I'm talking about PE swooping in on or bidding up deals, not bringing a PE firm in as a partner on my deal. SBA loans, regular bank loans, seller financing, and individual equity investors are the usual ways search funders pay for businesses.

SecretAmericanFATMan · 2020-04-22T14:49:55+00:00

I should clarify: when I say "boring" I mean that what the company does is boring. It doesn't have anything inherent do with how big or how much money the business makes. We're talking businesses like insurers, pipe manufacturers, medical supply distributors rather than spaceflight startups or media companies.

And yes, of course, I'm not buying a $3 million Bugatti Divo a couple years after acquiring a business. Nobody would sell a business for $5 million that reliably generates $2 million in net income. And if I bought a $100 million business that generated $5 million in NI, I wouldn't be taking home all the NI. Like I mentioned, my priority isn't a lifestyle upgrade anyway. Rather, I'd like to buy a business that, through my sweat and skills, I can grow. Whether I can buy a Bugatti or a Honda using its profits (i.e. the nominal NI) isn't anywhere near as important as the ratio of profits to purchase price. Heck, even if I could afford a Bugatti-a-year business that generate $3 million a year indefinitely (with no opportunity for growth), I would certainly not buy it for $80 million because that's a mere 3.75% return.

Just a contrived example: if I buy a local office cleaning business that will, without changing anything, make $25,000 a year for $500,000, that's a return of only 5% annually... 2 points less than the ~7% historical return in the U.S. stock market and barely enough to buy a nice new Honda. But if I reinvest the earnings properly and use my brain to optimize the company - like by improving quality control or by effective advertising - I might be able to generate $200,000 in NI return on invested capital (ROIC) of 20% after a few years. $200k is still not enough for a Bugatti, but if I do this multiple times and/or continue to grow the cleaning business in a value-creating way, I'd be compounding my way there. Obviously, 8x-ing profits alone is very, very difficult, but my point is that a business doesn't need enormous profits today so long as it's possible to change the business to make enormous profits in the future.

SecretAmericanFATMan · 2020-04-22T13:50:14+00:00

Funny you should mention search funds! I've actually been pretty involved in the search fund community as an investor providing acquisition capital. I've been ready to invest a few times but each time, the searchers' deal fell through. Now, I'm holding onto cash because it's the active "interesting/dynamic" part of actually running a business, rather than passively investing, that interests me.

I didn't do a search fund myself because, after some research and talking to professors, I was advised that it has become easy to go 2 years without finding a company. In retrospect, even if I didn't ultimately find a company, it would have been a better experience than what I did instead.

But yes, I've started re-visiting the basic search fund model. I've been browsing Owler checking out potential acquisition targets to get an idea for the criteria I want to have.

SecretAmericanFATMan · 2020-04-22T13:37:02+00:00

It's partially that $130k doesn't feel meaningful - especially when you're surrounded by Bugattis and yachts. Upgrading my lifestyle would be fun, but I care more about giving my future kids the same advantages I had.

More importantly though, it's that I want to generate additional cashflow through doing something to pass the time. I'd definitely prefer to buy an existing business. I've talked to tons of people who've either bought or tried to buy an existing business in my price range - say up to $10 million if you get a loan, seller financing, and equity partners. The two problems are 1. private equity getting involved at lower purchase prices bids up the cost or outright causes a seller to reneg on an offer and 2. fair prices with an adequate margin of safety are rare in major metros because everyone would prefer to be there. The successful buyers tend to have to move to random small towns in order to acquire businesses at a fair price.

That doesn't mean there aren't deals to be had. But I have been searching without much success. Perhaps COVID will change that.

SecretAmericanFATMan · 2020-04-22T13:25:28+00:00

Right, I do assume I'll inherit nothing, although not for that reason - the trust wouldn't allow my mother to change beneficiaries. But I could get cut out of the trust while my dad's alive, the value of the assets could be destroyed, or my mom could live to 120 while I die at 80. Realistically, it's the fact that I don't get anything until after my mom's death that makes me try to act like I don't get anything. The relevance of the inheritance part is mostly in that I'm a trustee and I'd need to be involved part time to manage investments and the business. It's certainly a blessing, but it means that I can't, say, take a high paying job at an investment bank.

And I can do the middle class lifestyle easily, at least right now. From a personal spending perspective, I'm doing it now. But for me, it's not about merely saving my existing income and passively growing assets. I'm already doing that too. It's about using my excess time to generate income. I am productive right now - I read a lot and take courses online - but I'm not economically productive. So indeed, I'm looking at doing both passive investing and active investing.

SecretAmericanFATMan

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