How to Buy Commercial Real Estate

In my 18+ years in the commercial real estate sector, I’ve guided numerous investors in buying profitable commercial property assets. As an advisor who focuses specifically on representing business owners and landlords, I’ve developed specialized expertise in deal analysis, financing, legal negotiations, and management of commercial real estate assets.

Key Takeaways

  • Commercial real estate can be highly profitable but involves more complex deals than residential properties. Careful analysis is key.
  • Different commercial asset classes like office, retail, multifamily, and industrial have unique risk-return profiles for investors.
  • Financing commercial purchases require higher down payments and stricter lending standards compared to residential deals.

How to Buy Commercial Real Estate

While commercial investments take more effort than residential properties, they can also be extremely lucrative for buyers who understand key nuances around analysis, working with brokers, getting financing, and property management.

This blog shares my insider knowledge on navigating the commercial property landscape to help you invest wisely.

What Is Commercial Real Estate?

Before diving into purchasing commercial real estate, it’s important to understand what constitutes a commercial property.

Commercial real estate (CRE) refers to any property used primarily for business activities instead of residential housing. This includes:

  • Office buildings from small spaces to skyscrapers
  • Retail stores and shopping centers
  • Multifamily apartment complexes with 5+ units
  • Industrial warehouses and distribution centers
  • Hospitality assets like hotels, motels, and event venues

Commercial properties are very different from personal homes in who owns them, the laws that apply, how they are managed, and tax benefits.

Houses are owned by families and people, while businesses small and large rent commercial spaces. So the owners have extra legal duties since these places provide income for the renters.

There are also different zoning rules based on how the property is used. For example, an office building has different rules than a shopping mall. Checking on these classifications is an important first step before buying a commercial property.

Steps to Buy Commercial Real Estate

Buying right comes down to an aligned process that covers identifying the right asset, financing, thorough diligence, negotiated offers, and strategic closing. Here are key steps that I guide clients through:

Finding The Right Property Opportunity

This begins with understanding your investment strategy – are you buying for stabilized cash flow, value-add potential, development opportunities, or owner occupancy?

Aligning motivations allows proper evaluation of different property types on metrics like:

  • Historical and projected rental rates
  • Occupancy trends
  • Options for refinances, lease renewals, and rent increases

For out-of-state buyers especially, trusted representation from local commercial brokers is invaluable for deal flow and realistic valuations.

Securing Favorable Financing Terms

Commercial lenders have different loan offerings and risk appetites based on factors like property types, location, age, and transaction specifics.

Expect intensive scrutiny of personal, business, and asset financials for loan qualification. Up to 50% down payments may be needed.

Ideal financing blends patience finding the most competitive rates with creativity tapping local bank relationships that commercial brokers cultivate.

Conducting Due Diligence

Buying commercial property requires extensive due diligence before closing deals. With help from specialized real estate attorneys, investigate:

  • Zoning specifications

    • Confirming allowable usage is essential
  • Contingencies and clauses in purchase contracts
  • Condition of physical assets

    • Inspections avoid surprises
  • The fine print in tenant leases

    • Impacts cash flow continuity

Leave no stone unturned to avoid unwelcome surprises! Have counsel review titles and documentation in detail.

Finalizing The Deal

Communicate early regarding ideal terms, as commercial offers require delicate negotiations.

  • Outline proposed terms in non-binding Letters of Intent before submitting official offers
  • Seek inspection contingencies and assignment clauses allowing you to transfer purchases
  • Make “subject to” offers contingent on securing financing

Experienced agent guidance is invaluable for constructing agreements that protect your interests while still closing deals.

How to Buy Commercial Real Estate

Challenges in Buying Commercial Real Estate

While commercial investments offer stiffer profit potential, below are common hurdles to expect:

Complex Operations

Residential property transactions tend to be quite formulaic. Meanwhile, no two commercial acquisitions ever go down the same way in my experience!

You need patient partners guiding you on property valuations, documentation nuances, legal technicalities, installation/maintenance considerations, and more.

Financing Frictions

Also anticipate lender scrutiny extending deals by 30-60 days, and factor in higher interest rates & down payments. Prepare for intense reviews of your financial position.

Management Headaches

Without diligent property oversight, tenant conflicts and infrastructure failures can multiply quickly. This remains an underappreciated risk for passive out-of-state owners.

If self-managing CRE isn’t possible, experienced property management should be set up before closing.

But also don’t let these realities discourage you! Advanced awareness allows preparing adequately to invest with confidence.

Commercial Real Estate Investment Strategies

While commercial properties pose bigger upfront investments, targeted approaches allow for maximizing returns:

Choosing Property Types

Top-tier offices, popular shopping areas, and centrally located apartment buildings usually have strong and steady renter demand. But buying them and making improvements is expensive.

In comparison, lower-ranked offices, fewer central stores, and downtown apartments might need big upgrades. But after fixes, they can make good money.

Alternative Financing Options

Beyond traditional institution debt, creative alternatives like private/hard money lending, crowdfunding, lease-to-own agreements & seller financing allow capitalizing on opportunities.

Lean Property Management

Contracting specialized property managers allows low costs while benefiting from their networks and infrastructure. Make minor tenant build-out allowances to secure longer leases, boosting valuations.

Focus Locations

Not all markets pose the same barriers. Secondary cities and downtown-adjacent neighborhoods often provide cash flow opportunities and more flexibility for newer investors.

Legal and Regulatory Considerations

Navigating regulations and agreements on commercial sales needs experienced legal guidance:

Know Your Zoning

Confirming zoning allows specific usage is essential. Also verify any limitations on modifications, expansions, or redevelopment before investing.

Review All Documentation

Enlist a specialized real estate lawyer to review sales contracts, property titles, tenant leases, association bylaws, and related documentation to avoid violations or loss of rights.

Mind Finer Print

Residential leases often span a few pages, but commercial agreements stretch over dozens of intricate stipulations allocating income, liability, and operations. Master the priorities.

Transfer Considerations

Understand easements and conveyances associated with the property based on historical transfers. Also, consider environmental exposures from past ownership.

In summary, CRE requires advanced planning, experienced partners plus tactical moves to build assets, not liabilities.

Investing in Commercial Real Estate: Common Pitfalls to Avoid

How to Buy Commercial Real Estate

Identifying Red Flags in Deals

Though investing in commercial real estate can make good money, there are also risks buyers need to look out for. Some things to check for that may be problems:

  • Financial records could show higher earnings than are real.
  • It may be hard to get clear details on previous renters.
  • Important details about rental agreements might be left out.

The property might also need more repairs and major upgrades than the seller says.

Buyers should look into these warning signs because they might show problems the seller is hiding. Going through all the files in detail, not just believing what the seller claims, can help buyers not end up with surprise expenses or issues down the road.

Choosing the Right Location

Picking the right spot is also really important. Being in a main, easy-to-access location where lots of people see it can hugely affect if the business there will make it. Buyers should research:

  • What types of buildings are allowed there
  • Any plans to build stuff nearby
  • Who lives in the area

Doing that shows if it should stay popular. Also, check if there is enough parking for a building that big so things run smoothly.

Managing Tenants

Carefully choosing and working with renters is important too, particularly for owners who live far away. Have strong approval rules when reviewing applications. Start with longer 1-2 year leases to ensure more reliable income. Avoid big costs to customize spaces. Rather pick tenants okay with them as-is.

Overcoming Financial Hurdles

Money issues can still pop up even with careful plans. Leave room in budgets for surprise expenses from repairs or higher taxes. Find backup funding sources with good rates, maybe from private lenders that take commercial property. If buying is too much of a stretch, partnering with other investors can help. They split the cost and want to make the property succeed too.

Mitigating Investment Risks

Mitigating risks is an overarching theme in commercial real estate investing. Evade overpaying through conservative valuation analyses and strict due diligence. Demand extensive inspector reviews of built assets, legal evaluations of titles/deeds, and forensic accounting of past operating expenses before closing deals. Only contract with credible, insured property management groups with demonstrable records. Patience in paying heed to warning signs allows for gracefully sidestepping hazards.

The Legal and Tax Implications of Commercial Real Estate Purchases

Understanding Lease Agreements

Following complex local rules and lengthy rental contracts takes specific skills. Experts need to know what can put renters in default. Like if they break certain clauses. Checking the fine print on transfers is key too. That part says what rights owners and renters have if one wants to leave. Also important is whether leases base rents on income before or after costs like taxes and maintenance.

Tax Advantages and Costs

Taxes also need upfront math – add up future depreciation plus what costs can have taxes lowered. Stuff like property taxes, insurance, maintenance. Commercial buildings get hit with way higher property tax rates that cut into profits. And maybe calculate delays from trading one property for another. That matters when deciding how long to keep it.

Reviewing Transaction Documents

Review all associated transaction documents, with particular attention to titles, zoning allowances, and existing permits that govern legal usage along rehabilitation options. Vet all current tenant leases and association bylaws for consistency. Seek environmental assessments to contain probable liabilities from past contaminations or activity.

Seeking Professional Guidance

With extra details in commercial real estate, advice from experts is very worthwhile. Local real estate lawyers can catch easy-to-miss legal problems. Accountants know the best structures to lower taxes. A good broker finds options. Property managers handle renters well. Trusted repairs pros fix issues. Having them before you need them avoids hassles later!

Complying with Ownership Regulations

Complying with multifaceted ownership regulations is an ongoing obligation. Continuously confirm insurance coverage adequacy across both asset risk and potential business interruptions. Adhere to mandated safety upgrades and disability access requirements during renovations. Prepare to pass regular property inspections depending on the commercial category.

Working with Industry Professionals for Commercial Real Estate

Successfully navigating opaque commercial deals relies heavily on experienced specialists across legal, financial, operational, and advisory spheres. Assembling a coordinated team is fundamental for investors newer to asset classes with added intricacies.

Role of Real Estate Agents and Brokers

Top commercial real estate brokers have access and experience that pays off. They depend on name recognition and make deals smooth for both sides.

Look locally for pros in the property type you want. Ones who get the area’s values, know all the paperwork and have bank connections. Lean on them to:

  • Explain complicated market factors
  • Introduce possible deals
  • Guide number talks
  • Help close purchases

Choosing the Right Property Manager

You see how good managers handle problems when renters complain or things break. Pick ones where tenants seem happy and repairs get done fast. Local companies can use their teams and contacts to run things more cheaply.

Check they stay on top of:

  • Filling empty spaces
  • Getting rents
  • Contractor prices
  • Other expenses

Read reviews to confirm they have enough background with office buildings, shops, apartments, or storage warehouses that match what you buy.

Importance of Lender Relationships

Building relationships with banks that give commercial loans can help buyers get good deals on money needed to purchase properties. When lenders know you well, they may:

Be more open to lending even if you don’t check every single box they normally want to be filled. Get you better interest rates.

The value of your property and financial records do still impact the deals you’ll be offered a lot. But if the lender knows you well personally, they can give extra useful facts about your experience and goals to their bosses behind the scenes. That type of detail is missing from just the forms you fill out. So working with someone familiar can mean faster OKs and money access.

Role of Accounting Partners

The taxes related to deals require expert accounting help for buyers newer to commercial real estate. Advisors should suggest the best owning setup considering legal risks and tax savings.

For example, they may compare companies, partnerships, or trusts to limit personal liability plus how to lower IRS bills. Ideally, find CPAs who understand key areas like:

  • Writing property values down faster
  • What daily costs are tax-deductible
  • Rules on selling one place to defer taxes when moving money to a similar investment

Have them list choices, limits, and paperwork required year-to-year.

FAQs

What’s the biggest risk in buying commercial property?

Excessive expenditures from unforeseen repairs or maintenance issues pose huge financial dangers without adequate planning. Always budget extra cushions when estimating costs pre-purchase.

Does location matter more for commercial vs residential deals?

Absolutely. Easy access and prominent visibility dramatically impact occupancy rates and resale potential. Thus factor proximity to highways, arterials, and population hubs when evaluating viability.

What’s better for novice investors – single-family or multi-tenant properties?

Single tenant triple net leased properties minimize headaches, especially for out-of-state owners, since tenants handle most operating expenses directly. This allows focusing on underwriting without property management complications.

What creative financing options exist besides traditional commercial loans?

Alternatives like private/hard money lending, crowdfunding, lease-to-own agreements & seller financing allow capitalizing on opportunities despite less operating history. The most creative investors explore combinations of debt and equity partnerships.

Should commercial real estate investors prefer local or out-of-state markets?

Initially, local markets with trusted representation allow gaining experience without remote management learning curves. Once operational capabilities mature, deploying capital into newer territories can dramatically grow returns.

What should I consider when buying my first commercial property?

When buying your first commercial property, you should consider the location, potential for rental income, maintenance costs, and the type of tenants you want to attract.

How can I find the right property for my business in commercial real estate?

You can find the right property for your business in commercial real estate by working with a real estate agent or broker who understands your specific needs and can help you locate suitable properties.

What type of professionals should I involve when purchasing commercial real estate?

When purchasing commercial real estate, you may want to involve professionals such as an accountant, real estate attorney, and commercial real estate broker to help navigate the complexities of the transaction.

Conclusion

Commercial real estate offers savvy investors a major upside through steady cash flows and equity growth. However, intricate analysis and partnerships are indispensable before purchasing assets more complex than residential alternatives.

This primer outlines specialized competencies around realistic valuations, legal technicalities, operational oversight, and financing creativity distinguishing CRE expertise. Master these through patience practicing due diligence, gathering knowledge, and surrounding yourself with trustworthy counsel.

Unsure how to apply these guidelines? As your advisor, I’m here to discuss suitability across individual risk profiles and wealth plans. Let’s connect to map your commercial options leveraging my decades of insider representation. Excited to advise how stepped implementation meets your investment horizons.

 

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The information presented in articles on our website or affiliated platforms is exclusively intended for informational purposes. It’s crucial to grasp that this content does not constitute professional advice or services. We strongly recommend our readers to seek guidance from appropriately qualified experts, including, but not limited to, real estate and other attorneys, accountants, financial planners, bankers, mortgage professionals, architects, government officials, engineers, and related professionals. These experts can offer personalized counsel tailored to the specific nuances of your individual circumstances. Relying on the content without consulting the relevant experts may hinder informed decision-making. Consequently, neither Tolj Commercial Real Estate nor its agents assume any responsibility for potential consequences that may arise from such action.

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