Buying commercial real estate can be a satisfying, safe and profitable investment if you take the time to do the due diligence by getting advice from experienced experts and know your risks before closing.
On the flip side, buying commercial real estate can be a risky business, especially if you are uninformed and are getting into real estate without completely understanding the industry.
Four Principals for Commercial Real Estate Investing
There are 4 reasons for buying commercial real estate; cash flow (income), appreciation (equity accumulation), depreciation (tax benefits) and principal pay-down (accelerated equity accumulation)
There are 4 types of commercial real estate investors; buy renovate sell, buy renovate hold, ground lease / lease backs, owner occupied.
Buy Renovate and Sell
Sometimes referred to as flipping, buying properties for this type of investment is speculative and should be done with the help of experienced professionals in your target area. These properties should be in good areas or areas undergoing gentrification, this will contribute to the amount of appreciation that can be realized in your exit strategy. Properties identified for this type of investment should have any or all of these characteristics; poor management, high vacancies, run-down condition.
Although you are looking for buildings in a run-down condition, you should avoid buildings that need replacement of major systems such as plumbing, electrical, and heating or cooling, as this type of improvement brings little in the way of return on investment in a short term flip project.
By using these principles when looking for a good "flip project" you will improve the odds that your investment will pay off.
Buy Renovate Hold
This type of investment strategy is for those who are interested in long term returns. Here the strategy is to make improvements to the subject property with an eye towards occupying the property with long term tenants. There are a number of ways to increase your returns here. Similar to the buy, renovate and sell strategy it is important to identify properties in good or turning point areas that have poor management, high vacancies and are run-down.
It is important to concentrate on getting long term tenants that will stabilize the cash flow in this type of property ownership. A hold and improve strategy allows one to make money from a number of different angles.
For example you could replace an old tired heating system with an energy efficient model that will pay for itself in the way of energy savings. Other large capital improvements can be spread out over time.
Making cosmetic improvements will enable you to increase rents and turn an under occupied, below market rent, poorly managed property into a cash flow machine.
Ground Lease / Sale Leasebacks
As a landlord you may benefit from the anticipated appreciation in the land after the tenant builds improvements on the land. Since you would maintain ownership of the land, you would be able to realize a profit at sale down the road or pass on the appreciated value of the land to your estate or heirs at death.
Furthermore, you might not have the knowledge and/or capital required to develop the land. A ground lease arrangement with a sophisticated tenant could result in development of the land in such a way as to realize its highest and best use. Additionally, a ground lease can provide you with a rental income stream.
The tenants can benefit in several ways from a ground lease. For example, you as an owner might be unwilling to sell a particularly desirable tract of land. A ground lease will allow the tenant to use the land while you retain your ownership interest. This also allows the tenant a way to avoid tying up capital in a large land purchase. Leasing the land, as opposed to buying it, will free up the tenant's funds to build improvements or pay for other obligations.
A sale leaseback works for the seller in a number of ways. It allows the seller to raise capital without borrowing, while giving them the ability to continue to occupy their facilities, take advantage of the tax benefits of leasing, use of capital from the sale to make needed or desired improvements to their business.
Typically in this situation the new buyer has a built in long term tenant and therefore an automatic cash flow. The new owner may also have the ability to take advantage of the tax benefits of ownership.
Owner Occupied
This type of ownership could be beneficial if you have a business and need all or some of the space for your own operations. This is normally a long term investment strategy. If there is space remaining you could realize cash flow from leasing the space.
In this type of ownership you will be able to exercise control over the functionality, comfort, health, safety and image you project.
Energy efficiency improvements reduce expenses and increase returns by lowering expenses, exterior renovations improve image, controlling the interior environment can improve air quality as well as contribute to your comfort, depending upon your business needs new equipment could improve upon the overall safety of operation.
In the long term you will have realized use of the building for your business, income from leased out excess space, accumulation of equity from appreciation and principal reduction on loans, and possibly the tax advantages from depreciation.
SUMMARY
Once you purchase a commercial investment property, don't forget to take care of your tenants. It surprises me that a lot of landlords could care less about their tenants. As a landlord you should do the things that are necessary to keep your tenants happy and encourage them to stay. After all, if your purpose is to earn a return on your investment, it is important to develop good long term tenants who care about your building and take care of it as their own.
Owning commercial real estate can be a rewarding experience. Until you become a seasoned owner, you should make use of the professionals available to help you to make your investments profitable. There is no shortage of Realtors, Financing Experts, Accountants, Architects, Engineers and Zoning / Building Code experts available to assist you in your quest to become the next big real estate tycoon.
Lastly, it is important to talk to those who will support you in a positive manner, and shy away from the naysayers who will try to discourage you. Just as there is no shortage of those before you who have made it work, there will be no shortage of those who are well meaning, but ill informed trying to assuage your desires. If someone who has NOT made money in real estate tries to discourage you make sure you remember to "consider the source". Uncle Fred might mean well, but the fact that he's not an accomplished real estate investor should inform you of the value of his opinion on the subject. He means well he just doesn't know what he's talking about. If Thomas Edison had listened to the well meaning people around him we would still be lighting the way with candles. With the help of experts, a little luck and your own perseverance, your illusions of grandeur can be turned into reality. Now, go buy a building . . .
