With a career spanning nearly five decades, Bob Nelson has won many awards and can point to plenty of successful deals—few as satisfying or successful as the one that won the coveted Oregon and SW Washington CCIM Chapter “Transaction of The Year” for 2017.
His Expertise Helps His Client Double Their Investment Yield and Avoid A $3.7M Tax Liability
In this award-winning transaction, Bob’s expertise was brought in by the clients a bit late. They were just about to receive an offer on their mobile home park—a property appraised two years earlier for $7M, and one that had very little debt. Previously Bob had counseled them informally to be sure they understood the tax consequences of a sale for whatever path they took.
As Bob was brought into the transaction, he estimated a potential capital gains and depreciation recapture liability of $3.7M, which would wipe out nearly 50% of their equity. He immediately started focusing upon a 1031 tax deferred exchange into a higher valued property that would legally protect the sale proceeds from taxation.
The Situation Bob Faced
This property had been developed by the parents of the current owners over 50 years ago and, as noted, had little debt aside from a small line of credit.
Bob came into the picture after the client had received an $8M offer through a California mobile home broker—an amount that didn’t excite the park’s owners. When a later offer for $10M came in, the owners became serious about selling, and avoiding tax liability.
As Bob became acquainted with the owners, they had two concerns that helped him decide how to structure the replacement property investment:
- They recognized that there was a significant upward price pressure on mobile home parks due the hot market in California. The concern was that rents may not rise as fast in the future. This could put pressure on NOI, and potentially reduce the overall future investment appeal.
- They had concerns about possible legislative movement in Oregon toward rent control. Their sense was that it was ‘only a matter of time’ before controls would be put in place, further impacting the benefits of ownership.
He also noted that there were two separate family generations within the ownership: a group of older investors who valued safety and stability; and, younger investors with a much more aggressive outlook. In fact, Bob humorously referred to the most dominant person as wanting to “use the net equity to buy most of the West Coast”. He recognized that to be successful, both interests would have to be satisfied.
An Award-Winning Approach
The first step Bob took was to establish an agreement between the owners that their investment goals would center around two things:
- Providing a strong and safe cash flow for the older owners lives, and
- Offering equity growth going forward for subsequent generations of the family
In his efforts, Bob was assisted by a younger member of the ownership team (who had been Bob’s printer repair expert previously). Once he and Bob had determined the criteria for suitable investments, that person was very aggressive and highly beneficial in researching investment opportunities.
Bob also worked to find a local funding source, as the current lender was a large national firm not known for flexibility or speed of execution. Working with a local well-managed credit union that had just revised their commercial loan policies to be more favorable, Bob was able to secure attractive fixed-rate ten year financing with no prepayment penalty, and the flexibility to extend at the tenth year for an additional five year term marked to market.
In terms of a replacement property, Bob identified a need for a minimum cap rate of 6.5% but established the target rate at 7.25% to leave room for deficiencies discovered during due diligence. Working with the ownership group, he also identified the investment “sweet spot” that offered both the long-term cash flow stability for the clients to live on and to protect them from rent control issues. Bob counselled the owners to consider a service-oriented retail center: an approach that offered both great stability and the potential for long-term equity growth.
The Important First Property
If you asked him, Bob would tell you that in commercial real estate “there will always be something”. After a relatively bump-free process in aligning the needs and expectations of each member of the ownership group and obtaining stellar financing, it was all important to find the “right property” to begin with.
The first property was a 10-year-old, 80,400 sf neighborhood retail center in a high traffic area of Redmond, Oregon. This well-built property flew though due diligence and obtaining the financing.
The beauty of securing Property One was that this single property was both a strong investment, and met all the qualifying criteria for a fully tax deferred exchange. It was both greater in purchase price and could take all the net sale proceeds. With Property One, the financial pressure of the $3.7M tax bill had been eliminated. By using financing, that left significant equity to acquire additional investment properties.
If Bob was unable to acquire any other attractive properties with the “surplus” 1031 funds, the client would have been taken from a 4% cap rate investment to a 7% cap rate investment, all while borrowing at an interest rate that was 4.25% fixed for ten years.
With much of the pressure removed by acquiring Property One, Bob now set off to satisfy the younger generation of the ownership entity.
The second property was more of a struggle. The initial asset the owners were looking at was a large older retail center in downtown Salem. However, after receiving a counter offer from the seller, Bob’s clients lost interest. But, on the way back to the car, they noted another building that caught their eye: a 35,600 sf office building that housed an art gallery and numerous smaller professional office tenants.
Bob’s clients were immediately interested in this property and instructed him to pursue it. During due diligence, it was discovered that a dry-cleaning firm had been a tenant for several decades. Fearing the worst, Bob asked for additional environmental inspection, which did not reveal significant environmental issues. In fact, the only real maintenance issue found was needed repairs to some exterior building ornamentation. Bob reduced this problem by having the seller fund a $75,000 reserve account dedicated to maintenance.
The third property was a series of three adjacent retail/office buildings owned by one seller in Eugene with a combined square footage of almost 23,000. Bob and his clients had looked at this property early in the process but crossed it off the list because of the price at $5.65M and lower cap rate.
In fact, the property had been listed for two years without any takers. Plus, several of the leases had expired, moving those tenants to month-to-month occupancy. Looking at the possibility of 50% vacancy with very short notice, Bob went to work on the listing broker.
He made it clear he wouldn’t offer more than $5.1M, an offer that would produce a respectable cap rate of better than 7.2% at current rents.
(Although this third deal was finalized, Bob had developed a great ‘fall back’ position. In case the lower offer wasn’t accepted, Bob planned to deploy the additional equity as additional down payment on Property Two—thus still avoiding any client tax liability).
In the End: A Win For Everyone
Commercial real estate transactions are always complex, there are lots of moving parts and contingencies to work through. What makes this particular transaction worthy of the CCIM Transaction of the Year Award are all the steps Bob took, from understanding the clients’ goals and crafting a transaction that met all of them, to working through the intricacies of three replacement properties, dubious results from a due diligence inspection, and sellers who thought way too much of their property.
As a result of his efforts, Bob’s clients have a highly diversified package of investments offering great NOI, stable long-term equity growth, and no future fears of rent control.
And a win for his clients is a win for Bob.
A Little More About Bob Nelson
With a real estate career spanning nearly 50 years, Bob Nelson as a Eugene Real Estate Commercial Investment Broker has seen and done it all. An expert in 1031 exchanges nearly since the beginning, Bob is an astute investment real estate strategist. Bob has taught real estate at the college level, he’s in demand as a speaker on investment real estate topics, and he runs a daily Real Estate Today radio show (KPNW 1120am at 5:30pm each evening).