It would be very similar in idea and structure to residential L/O's, however there would be very few (almost none) protections for the tenant.
Upfront option fee and the additional option payments could be higher (as it can be added to expenses for the business). You could easily create, close to a Triple Net Lease (the 'Holy Grail' of commercial RE).
Terms would be more negotiated between landlord and tenant rather than take it or leave it as we do with residential (if you were L/O'ing office, industrial, storage or multifamily), Inexpensive retail you could do a take it or leave it deal, as long as it was in a popular area and was relatively inexpensive.
Remember to add CPI (inflation) increase to the contract for both rent and price.
In the end it is simply a commercial contract (which is better for the landlord).
So if I were to do a LO for 7 cabins, (structured as 1 purchase) could I write it up with the following terms?
1. Asking price to be purchase price, with buyer to exercise option (if option is exercised) in 12 months.
2. Owner is responsible for utilities and all costs associated with property.
3. Buyer will manage properties for 25% property mgmt. starting immediately and all rents will be paid the first of the following month (Vacation rental mgmt. is a lot more than regular residential.)
...My goal here is to have the option to buy in a year that way I can ride out a full year with them. This way I can start managing these cabins and see what they can really do- and not have to worry about buying a dud...the numbers they have now are terrible- but I feel strongly that it is due to their property mgr.
You would likely want to put something into the terms where you keep all the proceeds and make a monthly payment. I have structured them in the past so that the payment increased with time. Or, that I received a discount for the first few months to allow me to get up and running.
More time for exercising the option is better for you. If you feel that you can increase the value of the property, then you can refinance the seller out down the road. This is risky unless you have money to back it up.
The seller will likely want some money upfront that he will keep if you don't follow through with your end of exercising the option.
The seller will want to have language about what happens in case of a default on your part. You will need to insure that he is making any mortgage payments as well.
The lease will probably be similar to a NNN lease in that you should be responsible for taxes, insurance, and all maintenance.
Thanks for the great insight Steve! ...I was debating about going abou this LO in one of two ways:
1. (Like you said) Pay them a set amount each month and we keep any amount over that.
2. Let them keep all rents received minus our property mgmt fee.
My thinking behind #1 is that we could make good money doing it this way, however if we set it up like a triple net lease, then our necks are on the line if the owner has misrepresented the condition or rental history of the property.
My thinking behind #2 is that doing it this way would really limit our risk, as well as benefit the owner as they would be getting a check every month. ...Which they aren't getting now!
If we were to at least offer option #2, would we write up a mgmt. agreement as well as some sort of paperwork for the option. (Is there specific paperwork for just an option?- As I'm typing this, I'm thinking that we went this route, there wouldn't be a lease involved, more of a mgmt contract with an option, and what would the paperwork look like on this?)
...You had also mentioned money down if we don't exercise the option as well as making sure that the owner paid their mortgage. Any recommendations on how/what to offer for a non-refundable down, and how to ensure the owner stays current?
However you structure it, you need to be filling a need for the seller. The terms that they agree to will be directly impacted by their motivation to part with the property. There needs to be a compelling reason for them to hand over the reigns of a large asset.
I have seen a couple of very different reasons but in both cases the seller did not want to take on any of the losses.
In one case, the property was losing a lot of money in the operations and the seller could not turn it around. He was trying to sell it but most of the buyers could not get financing based on the operations. In this situation, if the buyer could not turn it around and get financing, the buyer would lose some money. The real estate agent on this bought in with his commission which reduced the amount of the down payment (had to negotiate this as the seller did not want to pay the commission at lease commencement). The property was sold before the option date came up and money was made.
The other situation that I saw was with an investment group that wanted a hands off approach. They put the money down for a property and got the loan themselves. They had a select group that they worked with for these purchases which involved a lease and option contract that spanned a 5 year period. It was basically a 100% financing opportunity where the investment group wanted to easily take back control if the buyer could not make it work.
Back to your situation. Obviously, your motivation here is to see if you can improve the operations prior to purchasing. Do you understand why the seller wants out? You need to determine what this is so you can make a proposal or offer to them that would be of interest.
The seller's situation really sucks. The situation is that there is a cluster of around 30 cabins, a party house and a main office. 20 years ago they were all owned by one guy. To sell them, he has broken them into chunks and sold the chunks to several different people. Currently, a Realtor bought 10 of the cabins, the office and the rights to the name (Spruce Cabins). Another couple bought the 7 cabins, and the original guy still owns 9 and the party house. Well, the Realtor did property mgmt for all the cabins, problem is she (obviously) rents her cabins out first- so the other owners are not making money on theirs. The owner of the 7 cabins moved to a different prop mgmt company and they have done a terrible job- they are looking to switch companies yet again. This is where it would be a win-win. I could manage them, get them making money and in turn really know what I am stepping into. I would solve their mgmt. problem with the intent to take the cabins off their back. ...Not too many people (unless they own their own mgmt company) would be willing to take on a negative CF property like this one- what would they do with it? They would have to find a prop. mgr. and would find themselves in the same spot. I suppose I can write it up and the sellers can always say no. The way I see, I have everything to gain and very little to lose.
...I wrote up the offer on the cabins today. I also praticed having relaxed confidence about the whole thing. Here are the terms of the contract. ...We will have an answer by 10/20 (the owners are out of town).
Asking price: $335k for 7 cabins (2 duplexes, 1 triplex)
Office Price: $335k.
(Figure 20% down- either by owner or by me...change expenses by $500/month if carried by owner)
Current rents are zero. Zero!
Projected rents to be $4725/month= $56,700/year(30% occupancy)
Projected total expenses:$16,500/year
Estimate CF: $12,291/year
1. DD which will last 12 months. During this time we will manage them and turn them into the cash cows that they should be. Prop mgmt fee to sellers to be 20%.
2. During DD sellers will be acting as owners and I will be acting as prop mgr.
3. Seller's to carry 20% amortized over 30, at 7%, with a balloon in 5.
4. If DD produces poor numbers or major repairs, buyers retain earnest money.
We'll see what they say. I would be pleasantly surprised if they accept our offer as is, however I am expecting a counter offer. You never know unless you ask- right?
OK, what about this other alternative, if you still consider doing everything under just one contract.... $0 earnest deposit money, you get 50% of income, 20% is yours as management fee, the other 30% is counting towards down payment. If you walk away from the deal they keep the money you have credited as down payment (that 30%). Of course your offer also mentions that they will finance 25% of the price with a prime + .5 rate or something that attractive for you, interest only for two years.
Why this structure? They will get the same 80% but you get credited part of it. You are now producing money for a property that is not being rented at all, so they are already getting more than what they were bargaining for.
In any case I agree with SteveO, you should have two contracts, one for the purchase with a closing date 12 months down the road, and one where they hire you as the property manager for the property.