Tips For Buying Commercial Real Estate

It is well known that the American housing market is currently suffering. However, in spite of this, not all property markets are in decline. While the commercial real estate market has seen a slowing down, it has stayed healthy overall and now is as good a time as ever to be investing in commercial real estate. But what is commercial real estate for and what should you look for when considering the investment for your business or organization?

Considerations for Choosing Commercial Real Estate

Commercial real estate is property that is defined specially for business use. As opposed to personal or residential property, it is not made to be used for living quarters or other small scale endeavors. Instead, it focuses on housing a business or company. If you are considering starting a new business or if you are planning on expanding your current business, you may want to consider investing in commercial property. The following considerations can help you make the important decision of which property to invest in for the benefit of your organization.

What is your first impression of the location?
Does the neighborhood fit your business type?
What is the competition and support like near the property?
What is the hiring pool like surrounding the property?
What is the condition of the building and the property grounds?
What is the predicted upkeep needs for the property and the building?

Each of these important considerations can help professionals make the best decision possible when making the choice to invest in commercial properties.

Commercial Real Estate – What’s the Optimum Acquisition Strategy?

In our line of work, doing consulting for different high net worth real estate investors, we come across all types all types of commercial real estate acquisition strategies.

Some commercial real estate investors want to invest in only apartment buildings. Some investors wouldn’t touch apartment building if their life depended upon it because they think, as a whole, apartment buildings are over priced at this point in time.

Some commercial real estate investors want to invest in low-income housing. Others wouldn’t touch low income housing with a ten-foot pole, because they don’t want the headaches of collecting the rent and the abuse the property receives.

Some commercial real estate investors want to invest only in real estate where there’s an existing tenant to create cashflow. Others would prefer not have an existing tenant because they don’t want to pay the premium for the property.

As you can imagine, we could go on and on.

What’s fascinating is the seeming contradiction between the different strategies.

One investor’s ceiling is another investor’s floor.

But after reviewing the detailed business plans of literally hundreds of commercial real estate investors, there IS a common denominator to the strategy for their real estate ambitions.

Here it is in a nutshell:

First, they have a long-term plan. They are NOT opportunistic, looking at every single deal that crosses their path. They know their exact acquisition strategy. Whatever acquisition strategy they have, it fits into their overall wealth building strategy.

Yes, that may be common sense on paper, but in reality most commercial real estate investors, especially new ones, tend to shoe horn in whatever deal they are contemplating into their long-term plans.

They first key is that the strategy must drive the acquisitions, not the other way around.

That’s why you see some people sell off their entire portfolios of hodge podge properties. It’s a pain in the neck to corral them and so they try to get an unsuspecting person to take the winners and with the losers.

The second key strategy is they do their market research. Stated differently, they know the market or area they want to make an acquisition in.

It’s common knowledge for instance, that the major retailers know where the best locations are in the country. They just don’t put a store where think it will do well.

They put it up where they KNOW it will do well.

How do they know? They do their own research. They understand what PRIME retail space is to them based upon their needs down to the traffic patterns, congestion, local merchants and the specific growth areas within a community.

Now, some people think market research is ONLY for big companies; that it doesn’t apply to them.

If market research is one of the things you have a challenge doing, then you should look at it this way:

· Do you want to get the best deal on a piece of real estate?

· Do you want to be able to charge the highest amounts for rent or get the best price when it comes time to sell?

· Do you want to eliminate the risk of making an inappropriate acquisition?

Well, then you should become an expert at doing your research.

The third key strategy we’ve noticed is that commercial real estate investors rarely make an outright offer, unless it is a sweetheart deal. They prefer to submit to the seller a document called a Letter of Intent. It’s an informal offer. It’s an offer, which usually carries no penalty to either party if the deal doesn’t go through.

The purpose of the letter of intent is to allow the seller time to do specific due diligence on the property in regards to zoning, entitlement, infrastructure, etc. Unlike residential real estate, the commercial real estate market is “buyer beware”.

The due diligence process is performed so that the acquisition will allow the buyer to submit a formal offer with full knowledge of what he or she is buying.

The fourth key strategy is that they want to understand the math of a deal. Does the deal make sense? Is it doable?

You can execute the other three strategies flawlessly, but if the math won’t work, you’ll make a huge blunder.

There are dozens of different strategies for commercial real estate. Obviously, one size does not fit all. But hopefully, implementing these four acquisition strategies can make a profound difference in your commercial real estate wealth building success.

Beat the Crowd When Investing in Real Estate

We all are thinking about it and some of us are actually taking action and getting their hands on real estate investment properties. The longer the NY Stock Exchanges doesn’t produce desirable returns the more people are starting with real estate investments.

For most of us the obvious choice of properties are single family homes. Although you can invest in real estate without owning a home, most people follow the experience they made while purchasing their own home. This is familiar ground and the learning curve for doing a real estate deal of this type is pretty slim.

Of course there’s a drawback with this approach. The competition is fierce and there are markets where investors are artificially driving up the cost of the properties while completely discouraging first time home buyers. If this is the case, the burst of the real estate bubble is just a matter of time.

How do you avoid these situations and still successfully invest in real estate? How do you get ahead of the competition and be prepared for bad times in real estate investments as well? The only answer I have is commercial real estate.

Why commercial real estate you might ask? Commercial real estate is a solid investment in good and bad times of the local real estate market. The commercial real estate I’m referring to are multi unit apartment buildings.

Yes you will become a landlord and No you don’t have to do the work by yourself. You are the owner and not the manager of the apartment building. The cost of owning and managing the building is part of your expenses and will be covered by the rent income.

Apartment buildings are considered commercial real estate if there are 5 or more units. To make the numbers work you should consider to either own multiple small apartment buildings or you should opt for bigger buildings. This will keep the expense to income ratio at a positive cash flow. Owning rental properties is all about positive cash flow.

With investing in single family homes it is easy to achieve positive cash flow. Even if your rent income doesn’t cover your expenses 100%, the appreciation of the house will contribute to the positive cash flow. With commercial real estate the rules are different.

While single family homes are appraised by the value of recent sales of similar homes in your neighborhood, commercial real estate doesn’t care about the value appreciation of other buildings. The value of the property is solely based on the rent income. To increase the value of a commercial real estate you need to find a way to increase the rent income. The formula on how this is calculated would be too much for this short article. I listed a few very helpful books where you can find all the details.

What’s another advantage to invest in commercial real estate? Commercial real estate financing is completely different than financing a single family home. While financing a single family home you are at the mercy of lenders who want to make sure that you are in the position to pay for the house with your personal income. Commercial real estate financing is based in the properties ability to produce positive cash flow and to cover the financing cost.

After reading all these information about commercial real estate you want to go out there and dive into the deals. Not so fast. First, you need to learn as much about real estate as possible. In commercial real estate you’re dealing with professionals. If you come across too much as a newbie you will waste these guys’s time and your commercial real estate career ended before it actually started. Second, no commercial real estate lender will lend you any money if you can’t show at least a little bit of real estate investment experience.

What’s the solution to this? Go out there and do one or two single family home deals yourself. It doesn’t matter if you make huge profits to start off with. Most newbie investors are losing money on their first deal anyway. If you can manage to show positive cash flow with your single family home deals you are ahead of the pack.

My advice, buy a small single family home in a decent neighborhood and rent it immediately. This will keep your out of the pocket expenses at a minimum and you will have rent income to cover for your monthly expenses. Bonus, you gain experience as an investor and as a landlord.

Here’s another observation I made during my real estate investment career. Most people like to analyze, learn, discuss and analyze some more. They never actually got to do a real estate deal. They love to talk about real estate investments, but never did it themselves.

My approach to real estate investment was simple.

– I bought some books about real estate investment.

– I read every single one of them.

– I put together a simple plan on how I want to get started.

– I started looking for properties.

– I bought my first investment property 30 days after I started reading my first book.

– I made positive cash flow with all of my properties so far.

What is my point? You have to go out there and practice what you’ve learned. The only valid credential in the real estate business is practical experience. Having a couple of deals under your belt, you can go out there and start looking at commercial real estate and even impress seasoned investors with your knowledge. Because you made this experience by yourself and you know what you’re talking about.

The Skinny on Commercial Real Estate Buildings

So let’s get into it and break down the various kinds of commercial real estate buildings.

Retail – Strip Malls, Store Fronts, Big Box Buildings

Retail commercial properties are investments with the primary purpose of supplying space for stores and businesses to sell their goods or services. Anything from a mall to a stand alone gas station would be considered a retail commercial building.

Industrial – Warehouses, Manufacturing, Storage

These properties are designated for manufacturing businesses or other similar set ups. In most areas industrial property is strictly zoned as to limit noise, traffic and other elements that don’t mingle well with residential uses. Industrial property can be multi-tenant or stand-alone.

Office Centers, Medical Office and Sky Scrapers

When most people think about commercial real estate they think of office buildings or even high rises. Offices provide non-industrial workspace for companies and businesses. They can be as large as a corporation’s headquarters campus or a small office building offering suites to small businesses and professionals.

Multifamily Residential Properties

Just because this category of buildings houses living space for people doesn’t mean its not commercial real estate. Apartment buildings and other multifamily dwellings are valued the same way as other commercial real estate properties and can be a valuable addition to your real estate portfolio.

Mixed Use Buildings

There always has to be an exception to the rule, and in many markets the mixed use commercial building is becoming more popular. These properties mix housing, commercial and retail spaces all in one and can be very popular.

The Other Types Of Commercial Investment Properties

There is a large amount of properties that don’t fit nicely into any category. Retirement housing, hotels, motels, storage businesses and many others still are valued as commercial real estate.

The biggest difference in commercial propertiesis how they are valued as opposed to single-family residential properties. The latter are valued based on comparable sales while the former are valued on the income they produce. This allows the commercial investor to increase their property’s value by making improvements that increase the income.

As with any investment, prospective investors need to look at the ROI of the property in question, the monthly cash flows and the market as a whole. As you can see from the above list the options in commercial investing are bountiful.

Commercial Real Estate – Valuing The Cash Flow

Many investors don’t understand the power of commercial real estate. I too had reservations until I understood the power and safety commercial real estate can provide. Commercial real estate is similar to trucks. Trucks come in all sizes and all shapes – a Ford Ranger to an 18 wheeler. Commercial properties come in all sizes and shapes – a standalone building that houses a small restaurant to the Empire State Building. People read in the newspapers that commercial property prices are crashing. People notice the strip malls have a lot of vacancies and it scares them away. Let’s take a look at the power of commercial real estate and a quick note about market cycles. Commercial real estate is a business and is priced based on current cash flows. For simplicity sake, commercial property pricing is based on 10 x annual cash flow, not including debt service (loan). So a property that yields $10,000 in cash flow is worth $100,000. Regardless of the type of property, if you increase rents by 1% ($100) the value goes up a $1000. Decrease expenses by $100 and the value goes up $1000. So what? Let’s look at a simple apartment example.

A small apartment complex (10 units) has an annual cash flow of $50,000 and is for sale for $500,000. It has a lot of long-term tenants paying below market rents. You put down 20% or $100,000 (there are ways to make it someone else’s money). We’ll assume it is a positive cash flow property even with the debt service (loan payments). First a storage area is made into a laundry facility that provides $5000 on annual basis. You just increased the value $50,000. Next rents are raised the first year to market rents. Raising rents $50 per unit increases cash flow $6000. You just increased the value $60,000. That means you have doubled your original $100,000 in the first year and you get to keep the $11,000 cash flow. There are many more ways to increase the cash flow including: separate utilities and have tenants pay utilities, decrease vacancy, work out a deal with dish network and get paid, reduce maintenance costs, and more. Just by raising the rent $10 a year increases cash flow $1200 a year and increases the value $12,000. In three to five years you’ll have cash flows of $70,000 to $100,000 (less debt service which remains constant) and you can sell the property for $700,000 to $1,000,000. Now you see the power of commercial real estate.

Just like single family homes, not every property is a good deal. First you look for commercial properties in areas that have improving rents, increasing employment, and areas where the entire area is going through gentrification. Next you look for properties that have a value proposition – rents too low, poor management, ability to install laundry or some other measure to increase cash flow. You would be surprised how many buildings are poorly managed or have below market rents.

I’ve used an apartment as the example; however this same model works for office buildings, mobile home parks, strip malls and more. All types of real estate (all types of investment) go through cycles. When the economy is booming for example, the vacancy in office buildings goes down significantly (prices go up). Of course the opposite is true during an economic downturn. During economic downturns more people move to apartments, mobile homes and need storage facilities. By observing these cycles one can move in and out of various positions to minimize risk and increase portfolio value.