How to Get Started in Commercial Real Estate Investments
Are you interested in getting started in commercial real estate investments?
Lots of patience, knowledge and the right perspective are absolutely necessary traits for starting out in the commercial real estate industry. The professionals say success in this industry requires the willingness to spend a lot of effort and time up front in the research and identification of the right type of investment. And with the right steps and knowledge, commercial real estate has been shown as a proven method for building massive, passive wealth. It is a natural path for many investors, and offers numerous advantages over residential investments as well, including steady cash flow, more attractive leasing contracts, lower vacancy risks and higher income potential. But with investing, you must do your due diligence when seeking out the right deals before closing on them. Commercial properties could include office, retail space, industrial complexes, warehouses, mixed-use buildings and apartment buildings.
First, take your time and take the time to learn and educate yourself. Commercial real estate investments typically take longer than houses do — longer to purchase, to renovate, and to get sold. Just keep this in mind so you don’t rush things or get too impatient and just realize it is all a part of the process. Weigh all of these property types and choose your own niche based on whatever will help you reach your unique goals, regardless of your comfort zone. Don’t just buy anything just to buy it. Think of commercial real estate investments as a retirement home or big bonuses at work; it’s hardly a way to make quick cash flow to pay the immediate bills that are due. You need to be prepared to spend a lot of time up front upon closing each deal. Just remember that there is a learning curve, like with anything else, and that things will go faster over time. Don’t get discouraged, these things take time for the right investment deals.
Next, building relationships with other investors and private lenders are just as important as the learning process for this industry. For example, properties that cost $1 million dollars or more are frequently not within the financial budget of most of us as individuals, so you may have no choice but to get to know and work with other investment partners. In addition, many properties are often sold without ever being listed first, so the more people you get to know and grow your network, the more deals you will find. The right investment partner can provide the cash and/or credit needed to purchase a property, or several properties, and you can compensate them by paying a fixed interest rate or a percentage of the cash flow or proceeds from the sale.
It’s vital that you associate with experienced commercial investors who can answer questions that you come up while you are evaluating properties together. Do not lose a deal or buy a bad property because you didn’t understand certain terms, like ascertaining the costs of a maintenance person or trying to figure out what trash collection actually costs per year. Know who you can ask to get fast answers when you need them, and make your partner your new best friend.
In addition, don’t think too small. Instead, think big, think even bigger. Remember that the more units you buy, the cheaper they are per unit. It is no harder to manage 100 units than it is 50. You can indeed manage a lot more offices, apartment complexes and mobile home parks than you can manage residential homes. You hire an onsite manager and maintenance person, and you can give them a free apartment and/or a small salary and boom, you are then out of the property management role. Plus by living there, that person or people will most likely be on call 24 hours a day, making renters happier at your place, receiving a better reputation in the industry, and it keeps the property up to code and in quality shape as well.
Next, learn new formulas. Did you know that commercial properties have new and different formulas you will have to learn, like net operating income and cap rates? While market comps and replacement value play a part in evaluating commercial property, the true value is found by determining the net operating income. Net operating income is gross income minus operating expenses (and it does not include debt services). As a general rule, you can take the NOI of a property and divide by 10% (or an appropriate CAP rate for the market you are evaluating) to determine the value of the property. If for example you were able to increase the NOI on that same property from $100,000 to $150,000, the property would rise in value from $1 Million to $1.5 Million (based on a 10% cap rate).
Research good financing in advance. Commercial loans are totally different from residential loans and in some ways, that is better for you. While usually the down payments required on a commercial property is a higher percentage than loans on a house, commercial loans are often more lenient and more flexible than residential loans. You can also use a combination of financing. Before making offers, ask around and find out who the best lenders are in your area to use when buying commercial properties, as it may mean the difference between qualifying for a loan or not. You may find that you can purchase multi-unit properties with little or no money down through private investment partners as well.
Lastly, be prepared for those extra added expenses after purchasing each property when you are dealing with commercial real estate investments. After your offer is accepted, do your due diligence. This is the time to get a property inspection, get an appraisal, radon and pest inspection, and other inspections and tests required by law. These tend to cost more than they do for home deals. You may spend $5,000-10,000 on a deal, only to decide you don’t want to buy it after all.