One of the best ways to gain long-term wealth is through a commercial deal. Your business may have reached a point where you are looking to park your money in bigger investments. While commercial properties certainly require more time, effort and capital, the returns are often much higher as well. Like any other type of real estate investment, commercial properties also carry a certain amount of risk. The impact of a bad deal is often much greater due to the relative size of the transaction. If you are considering a commercial purchase, here are the five most important things to look for:
1. Location: As different as commercial transactions are from residential ones, the location of the property is still of the utmost importance. By definition, a commercial property is anything over four units. This means you could be dealing with anything from a mixed use property to a large apartment building. If you can’t find tenants, you won’t realize the cash flow you expect. The two biggest factors in finding tenants are price and location. Out of these two, location is always the most important – especially if you are looking to attract business tenants. Additionally, location will also dictate local commercial rules and regulations. Certain areas can be difficult to work with in regards to zoning and guidelines. The importance of location isn’t like a tired real estate cliché. With commercial properties, it is the most important thing you should look at.
2. Affordability: In terms of financing, the biggest difference in a single-family and a commercial purchase is the required down payment amount. On average, commercial properties require around 30 percent down payment. Additionally, some lenders require a certain number of months of reserve mortgage payments. Before you even make an offer, you need to acknowledge that your money will be tied up for several months, if not years. You also need to have funds available to hold you over from the time of purchase until you can fully rent the property. There will be carrying costs, utilities, a mortgage payment or two and other expenses that will need to be paid for a few months. There is a difference between being lean and spending all your money, and starting behind the eight ball. Make sure the property is something that you can afford, and are totally comfortable with at the time of the purchase.
3. Numbers: With a single-family rental property, the numbers are pretty straight forward. You usually have a pretty good idea of all the expenses on the property and can quickly calculate cash flow. With any type of commercial property, the numbers mean everything. The first thing you need to do is to understand the source of your information. It is not uncommon for a seller or listing real estate agent to bend certain numbers in their favor to make the property more appealing. This should go without saying, but never blindly trust anyone’s numbers. Next, look at the pro forma and understand what the numbers mean. Dig into the profit and loss statement, and see where every dollar is going. If you don’t understand or something doesn’t look right, it should serve as a red flag. You also need to be weary of projections. Anyone can project that the rents will increase in the coming year or the property value will rise by 10 percent. This doesn’t mean it will happen. Projections are nothing more than educated guesses. They may happen, but they may not. Do your own homework until you are comfortable with all of the numbers involved in the deal.
4. Property: Inspecting a commercial property is much more involved than an average single-family. The location and numbers are important in a commercial deal, but don’t overlook the physical condition of the property. With the increased number of units, the repairs and improvements will be much more expensive. Treat a commercial property like you would any other purchase you are making. If the layout is poor or the condition isn’t as good as you would like, it could cost thousands to get it the way you want. Deferred maintenance can also be an issue. Because of the high price tag to repair these items, the previous owner may have ignored problems for years.
5. Market: The location and the market are two different things. The location deals with the immediate area and surroundings, while the market deals with local supply and demand. An indicator of how high your rental demand may be could depend on how long the property was on the market for. Good properties typically don’t last on the market very long. If your commercial property was on the MLS for months, there may be something you have missed or need to look at longer. It can also be a sign that you may have difficulty selling at some point down the road. Obviously markets change all the time, but it is important to look at where your market is and where it may be headed.
A commercial property can be a great addition to your portfolio. Before you dive in, take your time and understand everything about what you are buying. If you are not comfortable, there is nothing wrong with waiting until the next deal. If you do see value and are ready to move forward, a commercial property can positively change your business.
