Interested in buying commercial real estate, but unsure about where to start? New opportunities are available every day for entrepreneurs like you who are looking for investments. Commercial real estate opportunities can be a great addition to your portfolio. Passive income as well as having the potential for growth are two of the best benefits.
Buying Commercial Real Estate – 5 Property Categories
Commercial real estate is generally used for business purposes or includes buildings with five or more units. It can be broken down into five main categories:
1. Multifamily – Residential properties with multiple units like duplexes, triplexes, or assisted living facilities that can house multiple individual residents or families in separate units.
2. Office Space – Dependent on size, this space is geared towards multiple tenants. Office buildings or medical offices fall into this category.
3. Retail – Areas designated for a business to sell goods or services. These are usually in easily accessible places. Shopping centers or mall spaces is in the retail category.
4. Industrial – Heavy manufacturing or light assembly areas ranging in size.
5. Hospitality – Establishments that help visitors as well as locals including places to grab meals and enjoy entertainment. A hotel or commercial style short-term rentals would fall under the hospitality commercial real estate group.
Buying Commercial Real Estate – 6 Things To Consider First
While the process of buying commercial real estate may seem similar to buying residential property, there are several differences. From generally higher costs to securing funding and getting tenants in place if the property is unoccupied, there are additional challenges with buying commercial real estate.
Valuation for the property can vary. This is because commercial real estate is not sold as often as residential properties. Additionally, commercial real estate can vary greatly in size and space, making it difficult to find comparable properties. This is why investors or buyers really need to do their research before purchasing.
If you are not sure where to start, here are some things you should consider:
1. Why are you interested?
This is kind of a silly question, but one you really should ask yourself. Why do you want to buy a commercial property? Is it for personal use or just investment purposes? Identifying your real reason provides the perfect starting point for you to begin your search. It also gives your agent an idea of what type of property to start searching for. You don’t want to spend the time and money acquiring a property that you will want to get rid of shortly after.
Starting a business, expanding your business or moving into a unit while renting the others could be a reason you are interested in buying commercial real estate. Depending on size and intended use, you may not profit from rental of units. However, not you will be able to build equity as well as sell your goods or services.
If the property is being rented in addition to you living on-site, you can profit in a few ways. Personal use makes it easier to manage the property. You will be on site and can take an active role on what tenants are selected. There is a downside though. Commercial real estate with multiple units can be costly if units are not rented. Vacant units still rack up bills including repairs and routine maintenance.
Managing tenant can also be a source of headaches. Rent can be difficult to collect from some tenants and conflicts of interest can arise depending on how the unit is used. Finally, check the zoning laws to see if there will be any limitations to the building or space.
Buying a building as an investment can come with many perks. The returns are normally 6-12% annually, higher than a single family property typically at 1-4%. On top of this you will receive tax advantages, have cash flow opportunities and have equity appreciation.
There are 5 strategies used when the owner if buying commercial real estate for investment purposes:
- Passive Investing: This is for an investor who doesn’t want to be directly involved with any part of the commercial deal. Generally, the investor will put capital into a deal through the stock market, crowdfunding, or a more active investor allowing them to collect their portion of profits from afar.
- BRRRR: Buy, Rehab, Rent, Refinance and Repeat! This is a passive income strategy involving flipping properties to rent out to tenants. The owner pays the mortgage and rents out the property while it builds equity. Then they refinance to fund the next investment.
- Fix And Flip: Similar to residential real estate, an investor will buy an older property or poorly maintained land, then fix it and resell for a profit.
- Develop: An investor buys land where they expect the value to grow and plan to develop it at the right time. This is generally developed into condos or townhomes where they can sell off the property to profit versus building other commercial properties. They will have to take into account the zoning laws of the area.
- Land Bank: Investors buy and hold land to protect and grow their money. By doing this, their money is tied to a fixed asset where they can sell or develop it in the future.
2. How Are You Getting Financing From A Lender?
Early on, find a lender for your commercial property. When you are searching for a lender, be sure to compare the products from several lenders. Check that the lender promises to cover what you need. Generally, lenders will offer options based on your credit score range. Ask about any additional fees or penalties as well, so you don’t end up with extra required payments.
Understanding the loan fully will only help you in the long run. Be sure you are clear on what they are willing to loan and if there is any collateral. A recourse loan allows the lender to go after additional personal assets if you default. A non-recourse loan only gives the lender the option to seize agreement-specific collateral.
The most common loans that are given are permanent loans, FHA loans, SBA loans, bridge loans and hard money loans. Each style of loan has it own positives and negatives, so researching and discussing your goals with the lender will help you find one that fits your needs.
3. Who Is Helping You With Finding, Securing and Maintaining The Property?
From searching for the property to maintaining it, putting together a team for each step of the process can save you money in the long run. A solid team can keep the property in order to keep things running smoothly and efficiently and save you money in the long run.
Some team members to look for are:
Real Estate Agent: Commercial real estate is its own unique field in the real estate world. Finding an agent who has sold and listed commercial real estate will give you a head start on the process. This agent will be able to guide you correctly on what is needed when proceeding forward on the commercial real estate deal.
Attorney: Finding a professional real estate attorney will save you time on closing and protect your interests during negotiations. They will also help you understand the applicable laws and ensure the agreement is legitimate.
Accountant: An accountant will handle the financial side of your commercial property. Whether you are doing your own business in the location or plan on renting/leasing space, an accountant will come in handy. They are able to prepare budgets, create reports and generate any statements needed for tax purposes.
Mortgage Broker: A mortgage broker can match you with the best lender to fit your needs. They are able to submit multiple applications, increase your approval chances and even track down agreeable pricing for you.
Contractor: If you need edits made to the space, finding a professional and reliable contractor will be beneficial to your project. They will also be able to repair arising issues. A reliable contractor will save you money in the long run.
Property Manager: If you do not plan on using the space personally, a property manager is a key player to ensure your success. This will be a person who is able to supervise the property and ensure that tenants are contributing to its value. Also, they will be the eyes on the ground to make sure that repairs or on-site issues are resolved. They also may collect rent, hire contractors, and meet with any future tenants.
4. Where Is The Perfect Property?
While most investors want to purchase a ready to go property in a bustling place, sometimes they are unable to swing it financially. This is why doing your research on different locations can help you find the right investment. An ideal property is one that will be desirable to you as well as potential tenants. Some things to focus on when doing your research are:
- Current Economic and Industry Trends – What are current economic and industry trends locally and nationally?
- Affordable Leasing – What price points are the leasings?
- Zoning Laws and Land Use – Are there any zoning laws or rules on land use?
- Property Layout and Design – Does the layout fit potential clients or your personal use?
- Potential for Growth – Is it a dying area or up and coming?
- Current Market Data And Trends – What is the current local/regional market showing?
- Seek Different Perspectives – What is attractive to potential tenants, business owners and brokers?
5. Do The Numbers Work?
You have done your research to prepare for buying commercial real estate. You’ve found some potential properties that fit what you are looking for in an investment property. Now it’s time to figure out if the numbers work while also ensuring that you will meet all legal requirements when purchasing the property.
This begins with the evaluation of the following variables:
- Location – Is this an area where you can find tenants, produce your product or rent the space? Are there any laws or regulations prohibiting certain uses? Unused space means extra funds away from you to cover during empty periods of time.
- Condition – What repairs are needed to use the property? What is it going to cost to fix or become ready for use? The condition can also cause unused space leading to more money out of pocket before finding tenants or producing your products.
- Real Estate Market – What is the current market like? If you are looking in a hot market, you may be paying a bit more than if it was a cooler one. This means you will have to figure out what number makes sense with the fluctuation.
- Compare Other Properties – Finding properties that are exact matches can be tricky in commercial real estate, so do your best. Find similar properties in location, size and condition to see how they are valued. This will give you a rough estimate of the value.
If you are having trouble figuring out the property value, there are 5 tools that are generally used to try to estimate it.
- Cost Approach – Investors pretend the property is not there and consider how much it would cost to rebuild the property from the ground up.
- Market Approach – Talking to your real estate agent about the worth of the property based on recently sold properties similar to the property you are looking at. While each commercial property is unique, you may be able to find properties that have some minor differences in the same area.
- Income Capitalization Approach – This is determined by figuring out the estimated income from the property in order to give a valuation.
- Gross Rent Multiplier (GRM) – To determine the GRM, the buyer would take the property’s price and divide it by the gross income providing the valuation of the property.
- Value Per Door – This is used more for apartment style commercial real estate where the investor will figure out the value of the building based on units (door).
6. What Is The Correct Offer?
You have done your research and calculated the potential costs and profits of the property you are interested in. Your next step in the buying commercial real estate process is to set up a strong offer. This is done using a Letter of Intent (LOI) that includes your terms and price. Your real estate agent will ensure the LOI is delivered to the correct person in order to start the process.
Once accepted, your attorney will review the accepted terms or make amendments to the contract before continuing the process. Before you get too far into the process, you may also want to have your accountant review the terms to identify any future tax consequences that may arise.
Once everything is agreed upon and the paperwork is finished, a closing will be scheduled. Having this work done by professionals minimizes the chance of issues arising. Be sure to congratulate yourself on closing day – you now own commercial property!
When advising clients who are interested in buying commercial real estate, our experienced ADKPP agents encourage potential buyers to learn as much as they can. It is not a simple process, and any time you spend researching and learning will go along way in helping you navigate with more skill and ease.
Even with a great team to help you find the right property to meet your goals, secure the financing and locking down a deal can take time and patience. If you can make it through the research phase and be patient, you will be gifted with an attractive investment opportunity with higher potential returns than your normal real estate deal.
Our agents excel at matching buyers with commercial properties in the Lake Placid region and would be happy to help you start moving towards buying commercial real estate to add to your portfolio. Contact us today to start looking!