Ep #618 – 2021 Commercial Real Estate Advice

Terry Painter, is the author of “The Encyclopedia of Commercial Real Estate Advice”. He is the founder of Apartment Loan Store and Business Loan Store – commercial mortgage banking and advisory firms that have closed over four billion dollars in commercial loans since 1997..

Here’s some of the topics we covered:

  • Why you need a mortgage broker
  • When to engage a mortgage broker
  • Offering memorandum
  • Pro forma vs actuals
  • Replacement Reserves
  • Expense ratio
  • Real Estate Taxes
  • Millage Rate
  • Current market
  • How inflation affects the rental market

For more information on our guest, please visit:


Full Transcript Below:

Rod: Welcome to another edition of “How To Build a Lifetime Cash Flow Through Real Estate Investing”. I’m Rod Khleif and I am thrilled that you’re here and I know you’re going to enjoy the gentleman we’re interviewing today. He’s got great energy and his name is Terry Painter and he’s the author of the “Encyclopedia of Commercial Real Estate Advice” which I understand is an awesome book and he’s also the founder of the Apartment Loan Store which ties right into what we do here on this show, which is buying apartments. So, I want to welcome you to the show, my friend. Welcome.

Terry: Thank you. It’s a pleasure to be here Rod.

Rod: Absolutely. So, maybe you could talk just a little bit about– well first of all how did you get into the business because you’ve got kind of an illustrious career. So why don’t you take a minute and talk about that and then we’ll drill down on some of the nuances of what you’re doing now.

Terry: Sure. I actually in 1995,’96, I had a chain of French bakeries and restaurants and they weren’t shopping malls and but what happened, what I really loved about it was actually building a new one and just I loved the development of it. Training the staff and so on. What happened is that it was quite expensive and my wife and my banker wanted me to slow down on new– just on opening up new restaurants and so anyway so my banker who’s one also one of my best friends you know, I asked him one day, how can I do what you do because you work on a new deal every day and I cannot– it’s you know, you want me to slow down in restaurants. My wife does too so you know, he said well it’s really going to be tough. You can’t just– it takes at least two years maybe four years to learn this business. So anyway, what I did is, I made a– at the age of 43, I made a radical career change and everybody thought I would fail except for my mom. And but I was so excited about this and you know, so yeah, and I found a– so actually and I just had to learn by doing deals. I mean, I was selling money for God’s sake. It was like you know, who doesn’t want to buy money. But it takes a while to actually learn all the intense underwriting guidelines. I was doing business loans and commercial real estate loans out of the gate and so, but what I found is that I actually just loved working on deals and I have closed hundreds of loans. I can’t wait for the weekends to be over so I could go back to work to this day. It’s actually kind of stressful for my third wife now but I have learned to spend time with my family more. That was a hard lesson. It’s important.

Rod: Well, yes. I got that memo myself. My greatest regret in life was coming home to our ten million dollar mansion on the beach and playing with my kids but being focused on real estate so much that I was distracted when I was with them to this day, my greatest regret. So, no, I love it buddy and so and it’s awesome that you love what you do and it comes out in your energy, and just so you know, I’m sure you know that but I’m sure you’ve heard that. But you know, so let’s talk about– let’s start with– I know that you speak to large real estate brokerages like KW and you educate the brokers. Can you talk about some of the stuff that’s coming up right now because we started to talk about it before I hit the record button and I think it’s really relevant for the people listening? So if you would speak about the market.

Terry: Sure. One phenomenon that’s happening today, that I have not seen in the last 24 years of working in this field is buyers actually wanting to close on a property and they have to exercise the financing contingency with you know, which gets close you know, kills the deal because they actually applied for the wrong loan. And because it’s so competitive out there you don’t know, you’re not going to get a second chance to start all over because it’s going to take probably 45 days with another lender and there are already backup offers on that property. So it is you know, so it’s really– if there was ever a time to make sure that you pre-qualify for the financing for a commercial property it’s right now. And where a residential property has two pre-approvals, a commercial loan has seven, and that is like a lot. And all it takes is one of those, let’s just say you know, let’s just say that the location you know, doesn’t make it or everybody’s on month-to-month leases and the lender and for that program, you apply for, they don’t like that. If it’s an agency loan.

Rod: Or too many residents from the same employer even as a–

Terry: Sure. Exactly. Or too many militaries, too many students.

Rod: Right.

Terry: So it’s really– what you really want to do is work– it’s really important to work with a really sharp commercial mortgage broker? Or you know, even if your bank you know, it’s okay to go through a bank but you want to make sure that you are pre– that you ask the bank what their qualifications are in those seven pre-approvals because banks have those too. So and those are all in my book. Yeah.

Rod: No. Nice. Nice. Nice. Well, you know, I will tell you that a good loan broker and I believe in– especially in people when they’re brand new at the very least and even beyond then to work with a loan broker because if you’re dealing directly with the lender and you don’t position yourself properly, you don’t present the deal properly, you don’t– the loan package isn’t properly created and put together, you’re going to lose that. You’re going to lose the loan. Where if you’ve got a loan broker they can clean all that up and present you in the best possible light. I mean, not obviously nefariously but accurately. But certainly, position you for approval rather than–

Terry: Exactly. Oh yeah, I totally agree with you. Totally agree with you. Where– because also, a skilled commercial loan broker is going to know all the underwriting guidelines for all their programs and they’re going to take a look at those seven pre-qualifications and make sure your fit for the program because otherwise what could happen is, you could actually get– you could get a letter of interest. Do you think the ledger has looked at everything? Well, you know what we do at our firm is we make sure that we run every– we run the whole deal by the credit manager or whoever is going to be signing off on approving the loan as well. And you know, and we could tell you– I could tell you that you need to do that as well. Make sure that the loan officer actually does run you know, off the flagpole.

Rod: That brings me to a question. You know, at what point should someone involve you, I mean, I know the answer but I’d like you to say it in a deal that they’re considering. At what point should they bring you in to evaluate what’s available for that deal. I mean, I think I just answered the question.

Terry: Well, here’s the thing, that’s what’s really good about working with mortgage brokers that are skilled in commercial real estate is that they will give you the time to actually help you evaluate deals. They’ll have great connections with real estate brokers, they could help you know pull and appraisers can help you know ballpark market rents and so on all these facts that you’re going to need to know. And they could probably be bought, you know, it’s really difficult with just the offering memorandum these days but we should talk about that Rod.

Rod: Right. Okay.

Terry: And these properties.

Rod: Yeah. Let’s do it. Let’s talk about the OM. Okay. Yeah, but so guys when you get– obviously for those you’re brand new when you get a package from a broker, you’re going to get an offering memorandum, okay and that’s going to be– and it’s kind of a misnomer in that when you present it to investors it’s also could be an offering memorandum. But yeah, let’s start– we’re talking about the broker offer memorandum right. Okay.

Terry: Exactly.

Rod: Right.

Terry: Yeah. Because there’s such a shortage of properties on the market. Such low inventory right now. What’s happening is that most of I would say, most of the deals that our clients are bringing these days like if they’re just desperate to find properties. They’re not sold on actual. They’re sold on potential. Now, think about it if you were buying a business, let’s just say it’s a tire store that was being sold on pro forma. Well, we want $250,000 for this business. It’s not you know, and because it’s not making the $90,000 a year that we’re stating, now it’s only making 25 but in two– in a year or so when you know, when you build the business up you’re going to get it up to 90. And we want– but we still want 250,000 for it because it’s a great business. Well, nobody’s going to do that, so the problem is that now people are being pushed into doing exactly that. We’re seeing an offering memorandum that says, number one is that they’re not using market occup– well if they are using sometimes, they are using market occupancy but they’re not really– what they’re not doing is doing it the right way where you have to take off 5% because that’s what the appraiser is going to do. That’s what your lender is going to do for a vacancy. And they’ll leave out like management they leave out things and they leave out you know, just probably one of the greatest ones is replacement reserves and because appraisers and lenders do that.

Rod. Sure.

Terry: And the most– what I love is, when I find it–

Rod: Before you move on actually, let me just– let me hammer home a couple of things you just said because I’d like to clarify. So you talked you know, the lender requires 5% vacancy. The other thing you’re not going to see on the pro forma is if it’s a value-add presentation. The higher vacancy year one, two, and three while you’re doing that reposition and that’s a newbie mistake that I see all the time.

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So value-add. What was the second thing you just said because I wanted to hammer something home on that as well?

Terry: Replacement reserves.

Rod: The replacement reserves. Guys, when you borrow money from a lender they’re going to make you put money in a reserve account for a potential roof replacement, parking lot resurfacing, HVAC units, chillers, so on and so forth. And it can be significant. I can tell you on this Sedona deal we just closed in San Antonio, 296 doors. Ours is gosh, I think it’s 350 which is kind of high but it’s warranted in this case and we’re able to use it for interior finishes as well which is kind of cool. So we’ll be able to blow through it pretty quickly. But the point is, a lot of people don’t realize they’re going to have that requirement, and of course that massively impacts you know, your numbers. So–

Terry: It really does. Yeah, it really does. Yeah, just like on a C quality property that needs some work, that doesn’t have that many– it doesn’t have like in the appraisal 40-years useful life left. It’s going to actually– it could be $350 to $400 replacement reserves. For a brand new property the minimum is $150 per unit per year so– but it’s one of those things that also– when especially my newbie syndicators and those that are– get, you know, that is just buying property, commercial properties, multi-family for the first time is that they, you know, they have– they really are looking at properties like when you– it’s just kind of like when you’re dating, it’s like they see all these– the best things first and they leave out replacement reserves. They don’t really– the other thing too Rod is quite often when somebody’s selling a property they lower repairs and maintenance. I see that’s the other one we catch. So what happens is that–

Rod: No. No. No. Let’s stop there. I’m sorry. Okay, I want to stop there because that is really important as well. Huge newbie mistake being you know, and certainly, there are sellers, unscrupulous sellers and most of them aren’t but some of them are that’ll do all the repairs you know, put all the costs or a lot of the costs associated with a property or maybe one of their other properties when they know they’re going to sell one of them because obviously anything that improves their net income is going to improve the value of the property. So that if they can leave some expenses off they might do that. But guys, you know what we teach at my boot camp, for example, is that you have to normalize the expenses. You’ve got to go through them line by line and we’ll give you, you know, ranges that you need to charge, and underestimating maintenance is one of the biggest newbie mistakes we see. Okay. Because you know, and it’ll kill you. I mean, it’ll bury a deal if you’re too aggressive.

Terry: Yeah. I would say that– I can’t tell you how many okay, so I’ve closed hundreds, hundreds of multi-family and commercial real estate loans. I can’t tell you how many times just as you’re saying Rod, that before a property you know, seller notes are going to sell the property quite a bit in advance, and what they will do is they’ll pretty up some of these numbers. it’s like– it’s got you know, just a couple of weeks ago, there was a property in Dallas and I said, do you realize that they’re showing about $300 per unit per year for the C-quality property for repairs and maintenance. I said this property is probably about ready to fall down to the ground. It’s probably in terrible shape if that’s all they’re spending.

Rod: Four times that would probably be more realistic. It’s probably $1200 a month yeah, would be more realistic you know, asset. Yeah.

Terry: So just as lenders we, you know, like all of our programs actually have minimums that they’re going to apply anyway for underwriting, for repairs and maintenance but we quite a lot you know, what I want to do is, I want to see like several years of financials to see if that’s really all they’ve spent or they did– they just trying to sell the property.

Rod: No. It’s almost always bs. You know guys, one of the things that– one of the calculations that you do when you’re looking at deals is called the expense ratio. And you know, it’s just how much are the expenses versus the income. It doesn’t include the debt just but all property-related expenses and if you see less than 50%, it better be a newer property candidly in most cases. If you see less than 30% it’s bs in almost every case. So you know, just keep that in mind.

Terry: Yeah. Oh, I’m afraid so and they see that really gets back to– for those you know, for those clients of yours, Rod that is just getting started especially, it’s like you could really be taken– just like any other relationships. Any other relationship. And what you want to do is you really want, like what we do is we turn over every stone and we really are looking for the misrepresentations you know, and some of them are– a lot of them are not intentional by the way. For instance, another one Rod, since we’re talking about expenses is real estate taxes is one of our biggest problems with one of the first things–

Rod: Probably one of the basic, biggest expenses you’re going to have on it.

Terry: Yeah.

Rod: You got to get it right.

Terry: Yeah. I go to the county when I– okay, first of all, this is a situation wherein almost all cases, the seller or the real estate broker listing agent is not trying to misrepresent the property but on a large deal like the one you disclosed it could be a difference of $20,000 a year maybe more maybe–

Rod: Or more. Yeah.

Terry: $50,000 a year. Just because they applied the millage rate. They’re using the millage rate that– which is actually how the county comes up or the city comes up and the city comes up with an assessment based upon other actual costs that they’re passing on to property owners. But that they could be using one that the seller had from some time ago and it’s not necessarily the current one. So, yeah. So quite often we find that real estate taxes are misrepresented and so–

Rod: And you could under it– so that’s a big one. Another one is insurance. You can underestimate the insurance like in Texas. Been a lot of storms and like on that San Antonio asset we estimated– what did we do, we did 450 a unit and it ended up being 495 a unit. My lucky property did so well. Improved so well in the NOI while we were under-contract which is very unusual that it offset that. So, yeah.

Terry: Yeah that was fortunate. But I can remember Katrina my God, in Florida, Louisiana, Texas those gulf states you know, properties were being sold with insurance quotes, I mean just from the seller that was like at least you know, sometimes a one and a half to even a third or at least one and a half times less than what that we would actually cost because of wind insurance.

Rod: Right.

Terry: And also, you’ve got to keep in mind is that if you’re talking about agency loans, Fannie Mae, Freddie Mac for your multi-family properties, they have fairly stringent insurance requirements including business interruption and cert insurance. Yes, there’s a fire–

Rod: Lots of add-ons.

Terry: And so you got to know really what your insurance– this insurance is another one so–

Rod: Let me tell you what happened on this deal. So the seller on this deal was only paying 250 a unit and so we basically double– I almost doubled it and like oh, we should be good. And you know, because they had so many storms there in Texas they have just gone through the roof and so you know, we were still a little short. So even us with our level of experience, my partner’s done six billion in acquisitions you know, can make– by the way guys not only do you need to involve someone like Terry in the deal early on, but you should also involve a good third-party property management company. Because they’re gonna know in that market what those expense line items should be. Okay. Based on properties they manage there and you know, they’re gonna know what the labor cost should be, what the, you know, what the staffing at that complex should be. So you involve you know, these are the experts you bring in on your team to make sure that you don’t make a big mistake, right. And so you know, this has been really good Terry. So talk about, I don’t know if we’ve finished up on the conversation around you know, this crazy market that we’re in right now and you know, and there are a lot of mistakes being made like, I reference to the San Antonio deal just because it’s top of mind. You know, most of these deals to get the returns right now that are going to attract investors are doing you know, 80/20 splits, 70/30 splits. Some I’ve even seen a 90/10. We did our deal at 50/50 because it was such a really incredible deal. Conservative. Super conservative. And still have you know, great double-digit returns. So you know, and we’ll be in the best and final on an offer and we’re just scratching our heads when we see what these things trade for. So I don’t know, you know, what these people are doing you know, if they’re you know, very very liquid and doing lower loan to values or I mean what are you seeing.

Terry: That’s exactly what’s happening is that– well first of all what’s happening is that we’re talking about these overpriced properties correct?

Rod: Right. Yes. Yes. That’s exactly what I’m talking about.

Terry: Okay. So what’s happening is that we’re– most of those are being purchased by 1031 exchange buyers who–

Rod: Yeah.

Terry: What they’ve done is that they– this is old money. What we call old money because they’ve made this from appreciation so many years ago that what they can’t do is buy a property that’s overpriced, they’re not as concerned as probably some of your clients are about putting in all these value ads because in some cases are looking for the depreciation to offset other incomes or but if nothing else but this was not money that they– that’s like some of your clients have really have worked hard for it to invest.

Rod: It came out of Hip National Bank right? You know, that money right.

Terry: And so it works in that case but and we are seeing people who are just like you know, the stock market just took a hit after just going nuts again for such a long– close to a year and then and so there’s a lot of what you know, what financial advisors are really recommending these days is also to diversify into real estate. Even if it has like a–as far as an ROI of you know, or cash and cash return to begin with of you know, 4% or something. Why? Because over time, just keep in mind that income real estate makes more money from appreciation than anything else.

Rod: Well, and, with this current administration throwing trillions and trillions of dollars into this economy what else do you think is going to happen? We’re going to have inflation. It’s already started and inflation doesn’t just impact the cost of goods it impacts rents.

Terry: Right.

Rod: So there’s an advantage there too.

Terry: It certainly does. And then what we see is when there’s inflation we do see certainly rents go up too. But they’ll certainly go up it which is a good thing and but also what happens is mortgage rates have a tendency to go up as well.

Rod: Yeah. They can. We’re locked like in our deal for 10 years so we’ve got a little bit of a cushion. But yeah.

Terry: Yeah.

Rod: You’re not– yeah. But–

Terry: So these prices should– they really do not make sense. I’m going to tell you a story, Rod. That’s we will really get this across and this isn’t why it still makes sense to invest in multi-family real estate at higher prices. And in June of 2018, I have a client that’s invested that’s you know, we’ve done lending for over many many years and she found this property, she was looking for a property in her neighborhood of Lincoln Park, Chicago and she fell head over hills for this older property that needed quite a bit of work but it was just a really great area, you know. And so what she would do, I said– but I pleaded with said, do not buy this property, please. Do not buy this property at a five and a half cap and then put you know 700,000 into these renovations, it just doesn’t you know, the market rents don’t support it. And you’re not going to be able to make ends meet and she said, she told me she said you’re just being so pessimistic. Please listen to me. My realtor says I could raise rents 20% da da da. She was getting– she was just– do not want it. She knew she wanted–

Rod: She wanna hear it. She let emotion get in.

Terry: Yeah what I’m going to tell you and I just told her I said, well I don’t see how you know, I really I couldn’t do a loan for her because the numbers didn’t pencil but she got a private loan and I’m going to tell you that I was wrong from one standpoint and that’s– she’s looking at another property. I talked to her a couple of months ago and in this market now that property has literally, I mean, the rents are over what she thought she was gonna get and cap rates are on that property are you know, in the high fours now. You know everything about that is– so she actually– she’s coming out really well but it just did you know, as from a lending standpoint I couldn’t see it.

Rod: Right. No, I get it. And it’s really tough right now because you know like there’s a– I’m not going to mention a name but there’s a guy that’s been on my show a couple of times. It’s a very well-known investor, billions in assets have his own jet and buy you know, A-class properties in the 200 to 300 per unit range, okay. And I was, like you know, what happens if the market shifts because that’s a yield play. There’s no value add. It’s just hoping the rents go up and I thought he was crazy but now with inflation, he might be laughing all the way to the bank, I will tell you. So yeah.

Terry: Yeah. We’re also seeing at our firm is just that properties that are actually in really good neighborhoods and that this one in Lincoln Park, Chicago certainly was and that there’s where you know, or anywhere where home let’s just say, just the value of the home is putting a lot of people out of the home buying market.

Rod: Sure. Sure.

Terry: And, yet they have good upper-middle-class incomes. We’re talking of over six figures and what they can do is they can actually, let’s say their rent they’re paying $1400 a month they could actually move up to 18. You know, and so we’re seeing that– so in better neighborhoods there– it’s amazing how much rents–

Rod: Sure.

Terry: Move up and that’s what happened in this case.

Rod: Sure. No. We’re not buying any C assets right now just because you know, who knows how long this Covid thing is going to be hanging around and the impact it has on so many different you know, the hospitality industry, the restaurant industry, and so we’re not doing C right now because the C, the one C’s that we have you know, kind of got hammered our Louisiana asset and but all our other ones did just fine. We’re in the, you know, 90’s as far as occupancy.

Terry: Yeah but it doesn’t make sense why buy a C property at almost the same cap rate as a B property.

Rod: Well, there is that too exactly. So, no, you’re absolutely right.

Terry: That’s nothing newer.

Rod: Yeah. Right. Right. Right. Right. Well, unfortunately, I’ve really enjoyed this. I’m bumping up against a hard stop here but I really enjoyed this conversation with you. And guys, guys, the name of his company again is the Apartment Loan Store. He’s the author of “The Encyclopedia of Commercial Real Estate Advice”. And I’ve really enjoyed this time with you buddy and I’m hoping that we continue this relationship. So appreciate you coming on.

Terry: Okay, it’s been fun, Rod. Thanks for having me.

Rod: Thank you.