One of the keys to a successful real estate business is a diversified portfolio. The different avenues you have for creating wealth the safer your business is. There are many investors who are intimidated at the prospects of a commercial property. They feel that the greater number of units the risker the investment is. The reality is that the opposite is often the case. Some of the wealthiest people in the world have benefited greatly from commercial investing. The right property in the right market can yield returns that cannot be generated from any other type of real estate. That being said there are a number of things you need to know before you get going. Here are five areas to focus on prior to your first commercial investment.
- Education. Investing in commercial properties is much different than your traditional single family purchase. Many times these differences can be complicated to understand. For starters a commercial property can be anywhere from five to twenty or more units. They can be stand-alone units, such as a strip mall, or connected to an existing business. It is important that you understand all of the various types of properties and what makes them different. You should also educate yourself on the numbers associated and which items effect supply and demand. You should also learn any local commercial laws and guidelines which can impact your purchase. Soaking all this information in can be frustrating and confusing at times. The amount of due diligence you would do on a single family purchase and a commercial one is often completely different. Before you get too far you need to learn as much as you can about the different property types and the process to close.
- Market. The market you choose to invest in is always important. With commercial properties it is everything. Large commercial buildings are dependent largely on the local economy to supply tenants in the way of business owners. If the market is poor you will have a tough time finding tenants which in turn will make your investment difficult to manage. The type of building or the location it is in is not as important as the local market. Market changes are never easy to predict but you need to look at indicators to supply clues. Has there been an increase in the general population? Are businesses leaving the market? Are there any changes to the taxes or other demographics that can have a negative impact? Before you consider a commercial property you need to know where the market is headed. You may be able to get a good deal on a commercial property but you need to know it will be strong well into the future.
- Valuation. One of the biggest differences with commercial properties is with how they are valuated. On a non-commercial property you look at comparable sales and listings and evaluate the data. You can get a pretty good idea of your list or sales prices by looking solely at this information. Just by the sheer volume of commercial sales this method does not apply. There are far fewer commercial sales in a given market. Inside of these sales the size, layout and style of the properties may be totally different. Instead of looking solely at sales you need to look at the income they generate. This method, known as the income approach, looks at the total rent that the property brings in over the course of the year. There are other factors that influence commercial value such as the specific tenant, the type of business, the market and the location. The bottom line is that commercial values can be a moving target and much more difficult to estimate than your average single family property.
- Tenants. An average single family lease is roughly one year in length. Some can be as short as nine months and others can last several years. With a commercial building the leases are much longer in length. The average commercial lease is three to five years. Because of the longer lease period it is critical to find good tenants. The strength of the tenant is typically based on the type of business they own. As simple as it sounds the stronger the business the stronger the tenant. There are also many different types of leases that a tenant can take. One expense you will definitely need to make is to have an attorney draft a specific lease for your property. Finding a commercial tenant takes more than simply making a post on social media and waiting for your inbox to blow up.
- Financing. The final area that you need to know is the financing. While there are a few similarities with residential financing commercial financing is very different. In addition to a strong credit score and 30% down payment you need income to support the property. Some of the income can be offset by rents received but most of it comes in the form of personal income. This needs to be document and evidenced with two years of tax returns. Another major difference is in the terms of the products offered. There are many more adjustable term and balloon mortgages in the commercial world than in residential. You can’t overlook this point. You may be satisfied with your loan today but in a few years’ time everything can change. If this wasn’t enough the total closing costs are also much higher than what you may expect. There are some steps that may be the same as to what you are accustomed to but many that are quite different.
You have a much greater chance hitting a home run with a commercial property than you do a single family residential. The key is to understand what you are getting into before you get started. Use these five areas as a guide to help you on your way.
