Learn from the Pros: How to Actually Buy Commercial Real Estate

Buying commercial real estate is challenging yet rewarding and it’s substantially different from buying residential property. You will need to consider the type of real estate investment, your investment strategy and timeline, whether you need commercial real estate loans, how to lease commercial property, and figure out your expected profit. 

Firstly:

• Research Research Research: Know as much as possible on how to invest in commercial real estate before jumping in. Research the property types, neighborhoods, traffic patterns, nearby businesses, vacancy rates, and market rents.
• You Can’t Do it Alone: Gather a team… a good team, especially if you’re just getting started. You will need an experienced real estate agent, a commercial lender, an attorney who specializes in commercial real estate, a licensed contractor, and a knowledgeable property manager.
• Know Your Numbers: Be familiar with comparable property sale prices, potential renovation costs, market rents, cash flow, and possible rate of return.
• Figure Out Financing: How are you going to pay for the property?! Know this before making an offer. You may have cash, a commercial real estate loan, a partner, or private funding.

8 Steps To Buying Commercial Real Estate

1. Know Your Why and Strategize From There: Why are you buying commercial real estate? What’s your goal and how are you going to get there? Write out your investment strategy and include a timeline as well as what you hope to accomplish with this purchase. This might also help you discover how to find investment properties.

2. Do Your Homework: This is where you will want to learn about the industry as a whole but also the area where you want to purchase property. Learn about the neighborhood, what types of tenants are there, who may be interested in moving in, and how much traffic the area gets…both foot and vehicle traffic. Also, learn about common industry terms and calculations.

3. Set a Budget You Can Afford: Take into account things like down payment and closing costs, monthly mortgage payments when the property is vacant, property taxes, and maintenance costs. Always include some overage so when a hidden cost comes up, your budget can afford to take care of it and look into how to value commercial real estate.

4. Line up Financing: Know how you’re going to pay for the property before you find it. There’s nothing worse than finding an amazing property and realizing it’s out of your price range. Your real estate agent will appreciate this too.

5. Choose Your Team: You may not be ready to hire everyone yet, but at least know who you’re interested in and start interviewing them. At the bare minimum you will need an attorney, real estate agent, property manager, a commercial lender, and a contractor.

6. Find a Property: Start driving around the area you want to buy in, look online, use sites like LoopNet and BuyBizSell, and tell your Realtor to send you properties within the criteria you’re looking for.

7. Research and Close on the Property: Once you find a property you like, visit it multiple times, review its financials and current leases with your attorney, and know as much about it as possible. Ask about lease terms, recent repairs, and property taxes. Once the property has been appraised and inspected, you will go to closing with your financing in place and it will be all yours.

8. Improve, Market, and Rent the Property: Now it’s go time! The property may need improvements and cleaning to make it rent-ready if it’s not already occupied. Then you will need to advertise the property for lease and have your realtor and property manager help find, screen, and move in a qualified tenant.

Tips for Buying Commercial Property

Be able to answer the ‘what, where, how, why, who and when’ concerning your investment in commercial real estate. Know what you’re buying and for how much. Be aware of the where: neighborhood, demographics, and amenities etc. Figure out how you’re going to pay for the property!

Answer why you’re buying this particular property and who is going to help you make it a smooth transaction. Don’t leave out the ‘when’ which includes your timeline for not just purchasing but also for improvements, marketing, and leasing.

Follow these important tips to learn how to buy commercial real estate:

• Clear Strategy and Budget: Stick to your investment strategy and your budget. Have extra room in the budget for unexpected repairs or hidden costs. They always come up!
• Knowledge and Research: The more you know the better. Attend a reputable seminar, listen to podcasts on how to buy commercial real estate, ask questions, and delve into researching the industry.
• Build Your Dream Team: You don’t want to cut costs here. Hiring the right professionals up front will save you time, money, and headaches in the future. ‘Oh, I can probably just do that myself’, should not apply to things like reviewing contracts or updating plumbing systems.

Advantages of Buying Commercial Real Estate

• Be Your Own Landlord: If you own a business, instead of leasing the space that houses your business, you can own it.
• Equity Appreciation: Historically, real estate values increase over time which gives you more equity in your property. Additionally, as you pay down your mortgage, you will also see an increase in equity and a decrease in the debt you owe on the property.
• Rate of Return: If you buy commercial real estate, you can expect an annual rate of return between six and twelve percent. This is considerably higher than what residential real estate typically offers.

Disadvantages of Buying Commercial Real Estate

• Complexity: Commercial real estate scares some investors off because it’s notorious for being more complex than residential real estate. You will need to calculate things like vacancy rates, capitalization rates (commonly called cap rates) and market rent.
• Fluctuating Demand: With more people working from home, the demand for commercial real estate decreases. This also happens when a large employer moves or shuts down their offices. As an investor, you’re reliant on the current market demands.
• High Upfront Costs: The average down payment required when buying commercial property for investment ranges from 15 - 35%. This down payment can’t come from a loan and you will need to show where the funds originated from. Other upfront costs include a property inspection, appraisal, property insurance, and closing costs.

Buying Commercial Property Vs. Residential Property

The deciding factors for buying residential or commercial real estate will include things like your budget, investment goals, available inventory, and time allocation. Typically, commercial real estate involves larger budgets, is riskier, takes up more time, and has the potential for higher rewards.

If your goal is to quickly purchase cheap properties and flip them, then investing in residential real estate is better suited for you. However, if you have upfront capital, aren’t risk averse, and want to own properties long term and make money over time, then commercial property may be the way to go. However, you may want to consider other types of real estate investment, for example buying residential property.

Some of the main differences in buying commercial property versus buying residential property include:

Property Type: Commercial real estate is normally grouped into eight property types. The first is multifamily properties which contain five or more units. This may be a small building with five units or a large apartment complex with 500 units. Additional property types include special purpose buildings, such as a church or event venue, office buildings, industrial buildings, hotels, land, and mixed use buildings. A mixed use building would house two or more property classifications. For example, there may be offices, and apartments in one building.

Tenants and Leases: Individuals, room mates, and families lease residential real estate and businesses lease commercial real estate. Residential leases are usually for shorter time periods such as one month or one year. You rarely see a residential lease for more than two years. However, commercial tenants often make large improvements and want to set up a business where they don’t need to worry about relocating after a short period of time, so leases tend to start at five years and go up to fifteen or even twenty years.

Determined Value: Comparables are the strongest determining factor for residential real estate. Comparable sales and adjustments for things like square footage, improvements, lot size, and number of bathrooms all affect the value of a residential property. Commercial real estate is valued less on comparables and much more heavily on revenue. The higher the cash flow, the higher the property value. Commercial real estate values tend to increase faster than residential property values.