Some guidance to light the way on your path to commercial real estate ownership.
With the real estate crisis nearly ten years behind us (and mostly affecting the residential market), investors are snatching up properties quicker than ever. However, acquiring commercial investment properties can be a complex undertaking that proves challenging for even experienced investors to time perfectly in order to maximize their investment value. The journey can be costly, disappointing, and stressful when you’re at the whims of the market and constantly shifting demands. Whether you’re looking at owning and renting commercial and multi-family properties, buying and selling commercial properties, or even building a business based on commercial real estate, review the tips below to seize your next opportunity and limit the common pitfalls.
Familiar with residential real estate? Let’s brush up on commercial.
Commercial real estate is valued differently than residential property. The income a commercial property generates is related to its usable square footage—obviously that’s not the case with a home. Also commercial property leases last longer than on residential homes, which can lead to a greater cash flow. The commercial real estate market is also much less competitive than residential with many properties priced too high for residential investors, yet too low for institutional parties.
Prepare to drop a sizeable down payment, or…
Most commercial lenders like to see at least 30 percent down when you come to the table—but that’s not a standard by any means. While private lenders like to see that you’re invested in the property, there are other ways to purchase an investment property without bringing 30 percent yourself. One option would be to find an investment partner or group who is motivated and willing to put up some, or all, of the cash in an equity-sharing partnership. Another popular avenue is using company assets (such as accounts receivable, other properties, inventory, and equipment) as collateral in the deal. Collateral is essentially an asset lenders use to secure the loan. When funding is provided, lenders place a lien on the asset(s), and if the borrower defaults the lender can seize the collateral to help recoup any losses.
Know these metrics before anything else
There are a few common ways to measure real estate value, including:
Net Operating Income (NOI): The NOI of a commercial property is calculated by taking the property’s first year gross operating income and then subtract any operating expenses for that first year.
Cap Rate: A property’s “cap” (or capitalization) rate, is used to determine the value of income producing properties. The cap rate is the Net Operating Income (NOI) to property value. For example, if a property was listed for $1,250,000 and generated an NOI of $150,000, then the cap rate would be: 8.33%.
Narrow down properties effectively
Let’s face it—nothing matters in real estate until you find a deal, ideally accompanied by a motivated seller. Once you find the place, there’s a number of factors to consider with the most vital being location, location, location, of course. The old adage rings just as true for commercial real estate as it does for residential. In addition, consider. . .
The Condition: Consider how the property was used, the wear-and-tear, and any potential environmental hazards or liability issues, such as lead paint or asbestos.
Any Limitations: Check into zoning restrictions, building codes, and covenants forbidding changes or alterations to the property. It’s also wise to look into any limitations around parking and handicap access.
It’s also worth the time to look into the area’s surrounding crime rates, school districts, and local amenities such as parks and retail shops. Better neighborhoods equal better profits.
Don’t burn bridges
As with life, relationships are a powerful tool. While the old adage “It’s not what you know, but who you know.” seems overused—it’s fitting given the relationships you build throughout the commercial real estate market are nearly as vital as your own knowledge and experience. Establishing and cultivating relationships with property owners, local businesses, and even other investors in your target area can make an immediate impact to your project and overall success.