Buying a commercial real estate property takes research and planning. You want to make sure you get the most out of your investment by taking the proper steps to conduct thorough research and consult professionals who can help you along the way.
Here are some do’s and don’ts of buying a commercial property.
For due diligence to be impactful, you must conduct proper research. This includes examining soil reports, appraisals, recent tax bills, zoning documents, and environmental site assessments. The due diligence process will validate the accuracy of the information presented about the property. The process can take months, especially if you uncover complicated issues. Hire a property inspector to determine the condition of the property and help to decide whether you will need to prepare for updating costs. Look into the background of the property and determine if there are any undisclosed easements or expired leases. Conducting due diligence should always be a thorough and intricate process. No two deals are the same, so try not to overlook any details that might be important to your investigation process. We’ve created a checklist to help during the due diligence process to help when buying a commercial property.
Determine the type of property you are investing in and weigh the economic factors. Are you investing in a multifamily, retail or office space? Each property comes with its own economic factors. Determine your risk versus reward ratio. Higher risk real estate investments try to reach for higher returns. Lower risk investments target existing assets that generate lower returns. Four ways to organize your investment assets are by categorizing them into core, core-plus, value-add, and opportunistic. A core asset is considered stable and predictable income. A core-plus asset has a slightly higher risk with low to moderate tenant vacancy. Value-add assets have a higher return than core-plus, but involve moderate risk. Opportunistic assets are considered the riskiest type of investments and are the least predictable because they tend to have the highest levels of debt and vacancy. Determine your investment expectations and what you expect to get out of the property. Come up with a list of expectations so you can calculate exactly what to expect and determine the best route for your investment strategy.
Consider whether you’re looking for a single-tenant net lease property or a multi-tenant center. A net lease property with a build to suit lease requires a landlord work letter, lease terms for the build to suit portion, and an understanding of how the lease should be handled if the developer or new owner is involved following construction. A single tenant net lease is responsible for paying one of either taxes, insurance fees, or maintenance costs in addition to the base rent. A double net lease is when a tenant pays two of the fees on top of rent. A triple net lease is when the tenant agrees to pay all of the expenses on top of rent. Gross leases are where the tenant is responsible for covering all operating expenses. Tenants will tend to choose this option to keep the rent at the same rate all summer, even when the building could rack up more cooling costs due to increased use of air conditioning. A modified gross lease offers a middle ground for both tenants and landlords where the lease rate remains fixed, even if the costs increase or decrease. There are multiple ways to lease a building and being educated on all options will help you be able to choose the best one.
Take some time to research the market supply and demand in the area you are looking into buying. Take a look at the market supply in your area. Certain property types do well on a macro level, but there could be an oversupply in your area. This will hinder your business from maximizing its full potential. Search crime rates in the area to make sure you are comfortable with any potential losses you could face due to possible theft or vandalism. Calculate the cap rate of your investment to determine the amount of cash flow you can expect to gain. Taking time to understand market cycles and comparing past cycles with the current state of the market you are looking to invest in will help solidify your decision in the long run. Investing in commercial real estate takes time and money and chances are, you do not want to lose an investment you paid a lot of money for. Take your research seriously and use it to develop a long-term strategy.
If you are looking to purchase a retail or office center, determine the likelihood of filling all vacant spaces in the current market state. Stress-test your investment by accounting for vacancy and rate fluctuations. Commercial properties are living, breathing vessels and it’s likely not every space in a multi-tenant center will be filled as businesses come and go. Be prepared for the fluctuation associated with multi-tenant centers. Look into investing into single tenant properties, as they tend to be less complex and usually require build to suit leases. Single tenant properties provide stability by utilizing the 1031 exchange, act as bond-like assets by promoting steady portfolio performance, have a steady transaction velocity, are experiencing a retail sales boost, and generate yield without excessive risk. Take time to analyze the type of property you are looking to acquire and make an educated decision with the help of your stress-test.
You know what they say in commercial real estate: location, location, location. Be extra cautious about where a property is located and examine the advantages and disadvantages of opening a business at your chosen location. Take a look at geographic location and decide if similar businesses are thriving in the area as compared to throughout the country. Certain regions might have an affinity for a certain type of business, whereas others might not take a liking to it. Analyze the competition by taking a look at similar businesses in the area who could potentially take away your customers and clients. Like-businesses who are too close together have a hard time seeing success when there isn’t enough variety to customers. Rarely does the close competition balance out the excess amount of traffic some businesses might not be able to handle. Take time to thoroughly investigate the location of your business and make predictions about its potential based off of location.
One of the biggest mistakes you can make in commercial real estate is overextending yourself. Determine your budget and if acquiring a property is feasible and within your budget. Commercial properties are investments and although they are intended to increase capital, they should not break the bank in the process. Determine your risk versus reward. If you need advice, consult with an expert, such as a lender or financial advisor, who can help you come up with a long-term investment strategy. Connect with professionals who can assist in property inspections and the entitlement process. Having a variety of available resources to help you along your way will ensure you are making the best decisions. Even the most educated and seasoned commercial property buyers refer to outside resources for help. Communicating with local experts will help you get a well-rounded scope of the market.
Property taxes can get in the way of closing a deal if they haven’t been resolved by the previous owner. Make sure all tax issues have been resolved by the seller in advance. Otherwise, you could face additional costs. Make sure you are working with a property inspector to determine the condition of the property before you buy. Examine the roof, plumbing, HVAC equipment, irrigation system, etc. to ensure the property is able to function day after day. If there are any issues with these systems, consider this in your negotiation strategy or ask the seller to make necessary updates. Title clearing, such as tax liens, judgements, encroachments, and breaks in the title chain need to be addressed before closing the deal. If there is a chance that something in the title clearing process is missed, the fallback could be your responsibility. Closing costs can quickly add up, so make sure to calculate carefully and factor these into your budget.
Buying a commercial property takes time and consideration. Understand your motives for investing and assess your options. Reaching out to professionals in the business can increase your chances of long-term success as you navigate your way through the acquisition process.