Sunday, December 25, 2016

5 Things to Consider When Buying Commercial Real Estate

Five Things to Consider When Buying Commercial Real Estate
These are my 5 things to consider when buying commercial real estate. There are many  questions and numbers to ponder before buying any property, so I've tried to keep all points as short as possible.  This is not an exhaustive list, but a pretty damn good one.  Here are my top 5 things to consider:
  1. Location
  2. Numbers
  3. Goal
  4. Due Diligence
  5. Intuition
Below, I will expand on each point.

1.  Location

Commercial Real Estate Location

  • Population
Is the population increasing or decreasing in the town in which you're buying?  I hope it's increasing.

  • Traffic (applicable to retail properties)

If you're buying a retail property, you'll want to know the traffic count.

  •  Convenience

Is the retail space located in a convenient spot for customers? Does it have convenient parking?  Is the multifamily property close to town, work and shopping?  Is the industrial warehouse you use easy for semis to get to?
Parking is important!  I recently wanted to purchase a historical building in a downtown area and turn it into an antique store, but I could tell that parking was going to be a problem.  Next door to this building was an immediate medical care facility that had heavy traffic. Therefore, the building I was interested in became less interesting due to its lack of parking.  If it's going to be inconvenient for my potential customers to park, then they simply won't come.  It was too risky, so I passed on the property.

  • Demographics

This is self explanatory.  Is the retail property located close to your target audience?  Is the multifamily property you're looking at going to attract tenants that will pay their rent and therefore take care of your investment? 

  • Zoning 

It's best to ask the county or city what the zoning code is and what it means for the property in which you're interested.  This is why the due-diligence period is so important.  If I have plans to buy a church and turn it into an events center, I better run the idea by the city hall to make sure the zoning and regulations are appropriate. Otherwise, I would be in for a big surprise after my purchase.
"Zoning categories and symbols vary among communities. A C-1 zone in one city is not necessarily the same as a C-1 in another. Typically, jurisdictions use letters of the alphabet as code abbreviations to identify the use allowed in a physical geographic area -- such as R for residential, C for commercial, and I for industrial. These symbols are usually paired with some number. The number can specify the level of use, or it may indicate a certain amount of acreage or square footage for that particular property."     Quote from Types of Zoning - Full Article 

2.  Numbers

Calculating Buying Commercial Real Estate

Ok boys and girls, let's run some numbers...
  • NET Operating Income (NOI)
This is the income that is left over after yearly expenses, such as taxes, repairs, utilities, monthly maintenance, etc.   
Gross income - expenses = NOI 

  • Capitalization Rate (Cap Rate)
Capitalization rates help commercial real estate investors quickly evaluate the difference between multiple properties.  It's in accordance with how much income the property is generating.  You'll often see a cap rate noted in Loopnet listings.  A cap rate is figured by
Net Operating Income ➗ Market Value = Cap Rate
So for example, if a property is listed at $100,000 and it's netting $10,000 of cash-flow per year, then
10,000 ➗ 100,000 = 1% Cap Rate
If you're investing in commercial real estate often, you'll probably come up with your own cap rate guidelines.  Maybe you'll only look at property with a certain % cap rate.  
  • Rent-to-Value Ratio
    Like cap rates, the rent-to-value ratio is just another way investors evaluate the difference between properties.  It's figured as...

    Gross monthly rental income ➗ Fair Market Value = Rent-to-Value Ratio                                             
  • Debt Service
If you are acquiring financing, what's your mortgage? 
  • Taxes 
Sometimes taxes are too absorbent to make the purchase make sense!
  • Property and Rent Appreciation Rates:

    North Carolina's real estate appreciation rate for 2015 was 5.04%.
    South Carolina's appreciation rate was 5.35% for 2015.
    Both have seen just over 4% average growth from 1975-2015.

    The average rent appreciation rates are between 3-4%.

    These numbers do not represent commercial real estate, but I think it's safe to assume CRE will at least keep pace with residential, if not better.  Commercial real estate also isn't hurt as much in market downturns.
  • Rental rates
If you plan on leasing the property after purchase, the best places to find comparable rates are Craigslist,, or just ask a real estate agent or previous owner.
  • Insurance
Factor in a 1/2 % of property's market value.
  • Repair Costs / Rehab Costs
What repairs will have to be made once you own the property?  Factor these repairs in before submitting your offer price.
  • Utilities
If you plan on building, having the city install electricity and city water, or you need a new well, these can be huge expenses.  
If you're buying multifamily or an office building, does each unit have their own utility box?  If not, this can be a somewhat costly expense to add if you want the tenants to pay their own electric and/or water.
  • Vacancy Rate 

    A vacancy rate is hard to figure, and quotes should be taken with a grain of salt.  It depends on many different factors, such as cost of rent, time of year, competition, etc. has the fourth quarter of 2015's vacancy rates:
    Office space 13.2%
    Industrial 9.4%
    Retail 11.2%
    Apartments 4.6%

    2016 was a good year for real estate, so I'd like to think those rates have lowered even more.  Again, something to think about, but I don't have a concrete number.                                           
  • Property Manager
Do you need this added expense or not?  If you're in the big-time with a large portfolio, you already have a property management system in place.  If you're a first time buyer or an investor on a smaller scale, you have to decide if you need someone to manage your property.  The questions I would ask you are: can you ask your tenants for money?  Are you willing to take an emergency call at 1 AM about a toilet overflowing?  Are you somewhat of a handyman?  If you answered no to all those questions, then consider hiring a property manager.   Some companies will charge a flat fee, some will charge between 8-12% of the monthly rent revenue.

3.  What's Your Overall Goal?

Are you going to rehab and flip this property?  Perhaps you plan on developing the land, or maybe you are the end user.  If you're like me, you just want to create cash-flow.  Simply asking yourself this question can solidify your motive and make sense of an offer price.  
 It's also a VERY good idea to bounce creative ideas off someone you trust.  What are all the uses for the property?  Maybe a vacant school could be developed into offices, a warehouse, loft condominiums, a play house or art studios.  

4.  Due Diligence

I hope, for God's sake, you'll give yourself a healthy due diligence period with your offer!  This grace period could be 10 days, 30 days, or more.  This is the time to:
  • further research the market 
  • visit the local courthouse and ask questions about zoning, regulations, history of property, etc.
  • call local plumbers and electricians that might know the history of repairs made on the property
  • Get any estimates that you might need
  • etc.
Due diligence is my least favorite part of the buying process.  It often will reveal obstacles, and you might end up walking out on the deal because of what you find.  However, it's better to be heart broken for a couple of weeks than be screwed for years.  

5.  What's Your Gut Telling You?

If for some reason the numbers seem great, but your intuition tells you that something isn't quite right, here's my advice.  I have learned that intuition is God speaking to you.  We are all scared to buy real estate, even the most experienced investors.  DON'T RUSH, sit down, get quiet and listen to what your intuition is telling you.  AND don't feel like if you walk away from this deal that there won't be another...there always is!  Be patient; the right property for you is coming your way.

If your gut says "YES!" then by all means, go full force ahead and never look back or doubt your decision.  You are doing what all successful people have're taking a risk, going head first and giving it your all.  You are now my hero.

Intuition and Buying Real Estate

1 comment:

  1. Good general advice for anyone getting into CRE. I like to ask myself on each acquisition, what is the worst possible thing that could happen with this property - and - what is the best possible thing that could happen with this property? I prefer the worst thing to be possibly breaking even and getting my money back. The best is "skies the limit" I prefer the the latter.