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My dad had purchased commercial real estate (Outback Steakhouse, not the franchise but the building and land) for $1.2 million in cash.

The rent is $5,000 a month in cash and he can pocket the full 5k every month. They pay for all repairs, maintenance and etc.
Thats $60,000 return on a 1.2 million dollar investment and he can get his money back if he sells the property and there is very little risk involved.

The contract is that the lease will be up in 20 years and the rent increases like 1-2% per year..

Since you guys are experts here what do you think about this investment? Can he get a higher return elsewhere or is this good.

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Comments (20)

  • bulge4lyf's picture

    Well, assuming rent increases 1.5% every year for 20 years and the property increases in value at 2% each year and he sells it at the end of the 20 year lease. He'll have an IRR of 6.61%. Not bad by any means if it's as safe as you say but still less than the historical stock market return.

    I'm talking about liquid. Rich enough to have your own jet. Rich enough not to waste time. Fifty, a hundred million dollars, buddy. A player. Or nothing.

  • In reply to bulge4lyf
    monkeysama's picture

    bulge4lyf:
    Well, assuming rent increases 1.5% every year for 20 years and the property increases in value at 2% each year and he sells it at the end of the 20 year lease. He'll have an IRR of 6.61%. Not bad by any means if it's as safe as you say but still less than the historical stock market return.

    If he reinvests the proceeds into the S&P every year he can bring the number up, but yeah.

  • monkeysama's picture

    Good rule of thumb: If you aren't making 10 percent returns you would be better off throwing the money at Asia.

  • In reply to monkeysama
    zeropower's picture

    monkeysama:

    If he reinvests the proceeds into the S&P every year he can bring the number up, but yeah.

    ....until he wipes out any and every gain made on the next crash.

  • In reply to zeropower
    rafiki's picture

    zeropower:
    monkeysama:

    If he reinvests the proceeds into the S&P every year he can bring the number up, but yeah.

    ....until he wipes out any and every gain made on the next crash.

    Because real estate always goes up in value.
    Not to disagree with you, it just had to be said.

  • zeropower's picture

    @Magua

    Thats fine, your point is valid.

    But i would argue you will never truly be wiped in notional value - i.e. your building will still be standing and youll be collecting rent. Single family dwellings are of course more prone to certain factors as we've seen in the housing boom/bust but for-rent properties are a good store of value. And either way, you always collect the rent whether or not its going up y/o/y.

    With equities, you can literally wake up to day after day of losses like in fall 08 where you don't know whats going on and are effectively watching your $ bleed to zero. And forget it if you've got a company in Ch11, no chance in recuperating anything there if youre long c/s.

  • 2x2Matrix's picture

    Definitely an interesting investment. That 6.61% IRR is on the low end, but if it's actually guaranteed, it's not bad. On the other hand, what happens if god forbid the building burns down or something?

    One of those lights, slightly brighter than the rest, will be my wingtip passing over.

  • In reply to 2x2Matrix
    cibo's picture

    2x2Matrix:
    Definitely an interesting investment. That 6.61% IRR is on the low end, but if it's actually guaranteed, it's not bad. On the other hand, what happens if god forbid the building burns down or something?

    Insurance?
  • RE_Banker's picture

    I don't know. A 5% cap rate is really low ($60K/$1.2M). You would typically only pay that much for an asset if it had a AAA/AA rated tenant. You won't be able to put that much debt on it either without running into DSCR covenant troubles (and using debt in RE up to prudent level is a good thing).

    Right now 5% looks good compared to treasuries, but as soon as interest rates go up, and the spread narrows, that investment doesn't look as good - especially if you are fixed at 1-2% rental uplifts.

  • International Pymp's picture

    It's a slightly lower cap rate than I might expect from that kind of investment, but if it's in an excellent location and the restaurant historically does very well I wouldn't be too worried. If your father is using it as a means of diversification (ex: he already has 5+ million in U.S. equities + a few million in treasuries and cash), it's likely a fine decision. There could also be taxation issues playing to your father's advantage.

  • mike55555's picture

    The only problem I see is the rent increasing by 1-2% per year. He should have waited until the inflation rate returns to the historical norm before making any 20 year agreement. Four years from today it is very likely the inflation rate will be 3-4%. Other than that, it is a safe, solid investment. I'd recommended selling the building and using the $1.2 million dollars as a down payment on a $6 million dollar commercial building. If real estate appreciates at 3% per year for 30 years you will be sitting on a $14.6 million dollar building that is paid off by that time. Or better yet leverage yourself as much as possible on volatile coastal markets in New York and California before you expect see a bull market. If you time things right, you can triple your money or more in as little as 5 years. And I don't want everyone to give me bullshit that the economy is dead forever and we will never see those gains again. Let's see how Silicon Valley real estate prices do when "next big thing" comes out.

    Men are so simple and so much inclined to obey immediate needs that a deceiver will never lack victims for his deceptions.

    -Niccolo Machiavelli

  • In reply to mike55555
    monkeysama's picture

    mikegj1:
    The only problem I see is the rent increasing by 1-2% per year. He should have waited until the inflation rate returns to the historical norm before making any 20 year agreement. Four years from today it is very likely the inflation rate will be 3-4%. Other than that, it is a safe, solid investment. I'd recommended selling the building and using the $1.2 million dollars as a down payment on a $6 million dollar commercial building. If real estate appreciates at 3% per year for 30 years you will be sitting on a $14.6 million dollar building that is paid off by that time. Or better yet leverage yourself as much as possible on volatile coastal markets in New York and California before you expect see a bull market. If you time things right, you can triple your money or more in as little as 5 years. And I don't want everyone to give me bullshit that the economy is dead forever and we will never see those gains again. Let's see how Silicon Valley real estate prices do when "next big thing" comes out.

    Yeah, except his dad is probably a pensioner looking for steady returns. Leveraging to the max is not what I would consider a sound strategy, even in normal markets.

  • collegekid89's picture

    No my dad is retired and he lives off that 60k now.
    He used to a strip mall worth $2.6? mil a couple years ago and put $800k down and got the rest of the money in loans.

    The rent there was substiantially higher. I think the total was around $11k a month. However, he said there was always the chance of a tenant leaving and that was a headache.

    He sold the property after owning it for 3 years and made a $200k profit

  • trade4size's picture

    2% cap on rent increases for a 20 year contract seems incredibly low. 5% cap sounds like a pretty good deal.

    "Oh the ladies ever tell you that you look like a fucking optical illusion" - Frank Slaughtery 25th Hour.

  • In reply to cibo
    2x2Matrix's picture

    cibo:
    2x2Matrix:
    Definitely an interesting investment. That 6.61% IRR is on the low end, but if it's actually guaranteed, it's not bad. On the other hand, what happens if god forbid the building burns down or something?

    Insurance?

    Well yeah, you'd obviously not lose the whole investment, but presumably in the meantime you wouldn't be collecting rent, which would drop your return. But if this is retirement income or something, it's a decent idea.

    One of those lights, slightly brighter than the rest, will be my wingtip passing over.

  • In reply to monkeysama
    mike55555's picture

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    Men are so simple and so much inclined to obey immediate needs that a deceiver will never lack victims for his deceptions.

    -Niccolo Machiavelli