Investors often say that buying property is a win-win proposition, no matter your market. Even in times of recession or economic downturn, there’s always a promise that the property’s value can appreciate over time. In the commercial real estate world, this promise is almost always backed up by entrepreneurs looking for space or your own company taking over the property for business purposes.
Whether you’re a fully-established business looking to expand and find a permanent home, a small business trying to get your feet beneath you, or an investor looking to capitalize on a growing market, an investment in commercial real estate can be a lucrative endeavor.
Why Should You Invest in Commercial Real Estate?
Compared to leasing a commercial space, buying a property can afford you numerous advantages (both financial and logistical in nature) and can also serve as an investment in the future of your company. From adding manufacturing facilities to additional office space or support centers, having a physical location to expand your business and help your bottom line in the long-run can be hugely beneficial to companies of any size.
Additionally, there are other benefits to purchasing a commercial real estate property as opposed to leasing a space, including:
- Complete Control. By purchasing a commercial real estate property, you’ll be provided a remarkable level of control over your company’s space. While you’ll be responsible for all utilities, insurance, and maintenance costs, you’ll also be free to make any improvements, expansions, or aesthetic changes you may want to make.
- Reliable Overhead Costs. You’ll never have to worry about rent increases when you own your own commercial real estate property. With a fixed-rate loan, you’ll have no exposure to detrimental changes in the commercial real estate market in your area.
- Tax Benefits. While your accountant can provide more details about your specific property’s potential for tax breaks and deductions, you’ll be able to write off your mortgage interest, property taxes, and other business expenses you wouldn’t otherwise be allowed to deduct on your annual tax filings if you were leasing a space.
What to Ask Yourself (and the Previous Owner) Before Purchasing Commercial Real Estate
If you’ve never completed a commercial real estate purchase before, you probably still have many questions. It’s a complex endeavor and one that can flummox any first-timer, so before you make a decision on a property, ask yourself, your team, and the current ownership the following questions:
Why is the Property for Sale?
There’s any number of reasons to sell a property, but knowing why the seller is motivated can help you understand the market situation and business realities in the area. If you can find out why a property is for sale, it can also help you in the negotiation process if the seller is eager to free themselves of the space.
What is the Property Currently Being Used for?
Beyond the zoning requirements for the property, it’s useful to consider what the property was previously used for and whether or not it was successful in that space. For instance, if you’re buying a space to establish a coffee shop and the previous occupant was a bakery that failed, you might want to consider a different location.
What’s the Condition of the Property?
Obviously, you’ll want a licensed property inspector to look into the details of the building’s condition, but it should be apparent from a simple eye test whether the concrete needs repair, drywall needs patching, or if the HVAC/heating systems are aged beyond efficiency. You should conduct a thorough walkthrough and take notes of any damage or potential improvements the space could use should you decide to make an offer.
What’s Happening in the Surrounding Area?
The value of a commercial property isn’t just defined by its condition, age, or appearance; it’s also influenced by its location and the neighborhood in which it resides. Take some time to walk around the area and look into any plans for development, upcoming construction projects that could impact your business, or improvements to public transit that could be beneficial to your company’s future?
Important Steps in the Commercial Real Estate Purchase Process
Any real estate transaction involves a lot of moving parts, but commercial real estate investment is a bigger fish. Whereas residential properties used for leasing purposes often garner lower returns on investment and shorter lease terms, commercial real estate requires longer leases (even exceeding 10-15 years) and monthly rent is calculated by square footage.
If you’re interested in investing in commercial real estate or purchasing a property for your own company, consider these important steps before you begin your search in earnest:
1. Why Buy?
As with any major purchase, you need to seriously consider why you’re looking to invest in commercial real estate property. Is it simply for the promise of a return on your investment? Or perhaps you’ve located a space that better suits the future of your business? Is your current space not accommodating your needs for growth? Look at what you want to accomplish with a commercial real estate investment and then find a property that could provide what you need.
2. Consider the Different Commercial Real Estate Property Types
If you’re simply looking to invest in commercial real estate properties and generate income by leasing those spaces, you need to consider the different types of commercial real estate. Of course, if you’re a retailer, a space built for retail shops should be your primary focus in your search. But from restaurants, coffee shops, retail spaces, office space, professional buildings, large-scale industrial complexes, and mixed-use facilities, each type has its own potential for generating income over the long-term.
3. Ensure Your Financing is Secure
Not only will getting pre-approved for a commercial real estate mortgage help you better understand how far your credit and liquidity can take you, but it will show potential sellers that you’re motivated and ready to move forward on a property.
4. Establish Your Criteria and Build Your Team
Aside from dedicating the energies of a new property search to a dedicated point person in your employ, it’s important to bring on an experienced commercial real estate agent specializing in your area of interest. In addition, you’ll want to seek out a commercial real estate attorney and a certified personal accountant to keep the numbers and terms on track.
5. Begin Your Search – and Do Your Homework
Now that you know what you’re looking for, you and your team can begin narrowing down the potential list of properties to tour and consider. It’s important to avoid settling on the first available option if it has shortcomings that might stymie your growth. You should also look into the property’s history before making an offer. How many upgrades/repairs have been performed? Has the building taken any damage from water/mold/asbestos, etc.? Only once you’ve built a list of pros and cons for each potential space should you move forward.
6. Make an Offer
Once you’ve found the right property for your needs, you’ll want to draft a Letter of Intent (LOI) showing that you’re pursuing interest in securing the space. In the case of a commercial real estate purchase, including a contingency clause in the offer letter can protect you in the event that the property doesn’t pass an independent property inspection. Once you’ve consulted with your real estate agent, accountant, and lawyer, you can move forward with the offer and begin the negotiation process.
7. Do Your Due Diligence
This part can get messy if you don’t have your proverbial ducks in a row. Once you’ve gotten the offer on the property owner’s desk, it’s time to fine-tune the process. You’ll need to get an ALTA survey, bring on an escrow officer, and property inspector. There’s a ton that goes into finalizing a property sale, so making sure things like property boundary lines, easements, access rights, titles, bills of sale, assignments of contracts, warranties, etc. are all lined up to avoid legal action (upon both the buyer and seller) post-sale.
Key Terms to Keep in Mind as a First-Time Commercial Real Estate Owner
If you’ve previously invested in residential real estate or have simply leased your previous commercial real estate properties, there are numerous new terminologies you should be aware of before pursuing a commercial real estate transaction.
- Ad Valorem – Ad Valorem is a tax calculated based on the current value of the property in question.
- Debt Service Coverage Ratio – This is a metric that analyzes how much of your operating income goes toward paying down your debt each year.
- Capitalization Rate – Capitalization rate is measured by how much income the property in question takes in against the total market value of the property.
- Cash on Cash – This shows how much income your organization has made versus how much you’ve invested in the property, including the amount of your initial downpayment.
- Loan to Value – How much money you’re borrowing against the total value of the property you’re trying to purchase.
- Vacancy Rate – This is hugely dependent on the market in your area. Vacancy rate shows the percentage of comparable, vacant properties during the same time period in your immediate area.
- Useable vs. Rentable Square Footage – Just because you’re offering a certain square footage doesn’t mean that’s usable by the tenant. “Rentable” square footage can include the usable square footage of the space plus a certain percentage (or pro-rata share) of the building’s common areas, including shared meeting rooms, lobbies, restrooms, utility closets, elevators, parking areas, etc.
- Net Operating Income – NOI refers to any income you generate from the property after expenses are taken into account, but does not include load payments, value depreciation, or taxes.
Successfully completing a commercial real estate deal is a monumental accomplishment that takes time, effort, and a lot of energy. But as rewarding as the endeavor can be in the long-term, entering a commercial property ownership role can be frustrating if done without a cohesive plan of action. With the information above, you’ll be better equipped to handle the ups and downs of the entire process.