Make Money With Commercial Property Rentals

By: Steven Gillman

Commercial property rentals wit triple-net leases mean little management and high returns. However, this can be a tough market to break into, and you can have negative cash flow on vacant storefronts for a year at a time.

How about a real estate investment in which the renter pays not only the rent, but the taxes and insurance, and maintenance costs as well? That is the idea behind the "triple net lease." It is common in commercial real estate.

Many companies make too much money on their products to have their capital tied up in a building or real estate. For example, if a retailer can turn over $500,000 worth of inventory six times per year, making 10% profit each time, they make $300,000, or 60% on that capital. It wouldn't make sense to have that $500,000 invested in a building. This is why they rent. In fact, many large retailers will buy real estate, build their store, and then sell it to an investor who leases it back to them.

The triple net lease means that the investor has a guaranteed return on his investment, more or less. Rising property taxes or insurance rates don't affect him, because the lessee pays these, as well as maintenance costs. Essentially, the owner of the property just collects the rent for the term of the lease. As you can imagine, these are deals that many investors would love to have.

Commercial Property Rentals - An Example

Suppose you find a building that is suitable for a furniture store or other retail store. You can get it for $600,000. You find that the bank will loan you $480,000, or 80% of the value - but only if you have a lease first. You have enough cash to invest (or a partner does), so you can handle the deal if you can find a renter.

The seller will give you an option on the property for $10,000 for four months, and will apply the option fee towards the purchase if you can close the deal.

This buys you time to find a renter. Of course, you will lose the $10,000 if you can't close the deal.

You hire a good real estate agent who has experience with commercial leasing, and get busy. After two months, you find a hot tub company that seems to be doing well and wants a store in your area. After checking out their references, you negotiate a rental rate of $4,500 per month on a ten-year lease. They also pay property taxes, insurance and maintenance expenses.

The bank loan is due in ten years, but amortized over 30 years, with eight percent interest. This means your payment will be about $3,500. Since the renter pays virtually all of the other expenses, this means you get positive cash flow of about $1,000 per month, or $12,000 per year. With a down payment of $120,000, and about $30,000 in other expenses, you have $150,000 invested, making it a cash-on-cash return of about 8%.

Your total return will be substantially higher. This is because you will get a depreciation allowance for the building at tax time, and you gaining equity with each payment on the mortgage loan.

Of course the company you rent to could go bankrupt. This is a real possibility. What happens then? You rent out the building to a new tenant hopefully.

This is where commercial real estate gets tricky. You have no cash flow when the building is empty, but you still have payments on the loan, as well as taxes, insurance and maintenance. In the example given, these could add up to $4,200 per month. You may also have to pay utilities, and advertising costs, and a fee to an agent to help you get the place rented again.

Now for the really bad news. It is not uncommon for commercial real estate to remain empty for a year or more. It takes time to find the right tenant for a building. It isn't anything like residential real estate, where there are always a few buyers around, and they can live in many types of houses. Each business has its own particular needs.

Imagine that it takes thirteen months to get the place rented out again. The good news? Perhaps you can get $250 more rent this time. The bad news? Thirteen months of expenses, plus the expenses of re-renting it will likely add up to about $60,000. That means you have $210,000 invested now, and the cash flow of $15,000 represents just a bit over 7% cash-on-cash return.

If you don't have the $60,000 to cover this period of vacancy, you may just lose the property - and your investment. As you can see, you need to have some large cash reserves or access to cash for situations like this. This is one of the reasons that there are relatively few investors who pursue these kinds of deals.

Of course, this means less competition than in some areas of investing. Then, when you do get a good ten-year tenant on a triple net lease, you get to enjoy the cash flow with none of the usual headaches of being a landlord.

You may want to find a mentor and study the market before considering any commercial real estate investments. Find out what kind of returns investors are expecting. Commercial property rentals have to pay you a higher return than residential property, because the risk of long vacancies is greater, as is the possibility of rents going down.

Money Management
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