Strategies for Buying Commercial Real Estate

by : Kimberlyn Williams

If you've grown weary of paying rent for your current business space, or have considered purchasing commercial real estate as a long-term equity investment, there are several important factors that can maximize your financial opportunities and minimize your risks.

First of all, do your homework and educate yourself on the various costs involved. Unlike residential real estate, commercial property has extra fees and costs, which are not immediately apparent. So make sure you have the complete picture before you buy. Potential property expenses include (but are not limited to):

Ã?â‚?? Property taxes - Underwriters use the real tax numbers instead of an estimate used for residential properties.

Ã?â‚?? Insurance - The requirements the underwriter will have are often different (and more) than what the owner is currently and usually carrying. The buyers will have to comply with the underwriter's insurance requirements.

Ã?â‚?? Management fees - Costs will vary depending on your set-up. If you will be taking care of things like landscaping contracts and building maintenance, you may be charged a simple flat fee for managing the tenant administration. If you outsource everything to the firm and the building has several tenants, the fees may be based on a percentage of the rentable square feet (RSF) or usable square feet (USF) for each tenant.

Ã?â‚?? Replacement reserves - These are funds set aside for the replacement of things like pavement, HVAC and other systems that have a limited, predictable lifespan. On many transactions, replacement reserves are established by having a Property Condition Assessment (PCA) done by a qualified engineer. The amount of reserves required will be determined by the engineer's estimates of the remaining life of the major systems.

Ã?â‚?? Tenant Improvements and Leasing Commission (TILC's) - Expense to improve the property to attract new tenants to new or vacated space, which may include new improvements or remodeling. This expense applies to office, retail and industrial properties.

These expenses don't include ongoing fees such as maintenance and administrative costs. All such costs need to be figured in and the predicted cash flow determined when considering the cost of the property.

Once you know your what your expense outlay is going to be, it's time to assess your financing. Where will your money be coming from? Options include other investors, business partners, your own capital, borrowing against other investments or properties, and bank loans.

Many purchasers jump immediately to the last option. However, it is not uncommon for banks to turn down business owners even if they have great credit and a positive cash flow. Reasons include:

Ã?â‚?? Loan size - The loan amount requested might exceed the limit the bank can lend to any one borrower.

Ã?â‚?? Borrower can't prove income - In a large percentage of cases, the tax returns and financial statements of small business owners do not support the loan amount. Most small business owners do not show an income; instead they show a loss to avoid taxes. This results in an automatic decline for most banks.

Ã?â‚?? Portfolio management - A high quality loan request may be denied because the bank has to keep its portfolio balanced. Regulators keep an eye on the particular property types a bank has in its portfolio. If the portfolio contains too much of a particular property type, the bank may not be allowed to lend on this property.

Ã?â‚?? Property type is outside of their specialty - Many banks specialize in a particular type of lending (such as non-owner occupied commercial property loans). If a borrower requests financing for a property type other than their specialty (such as owner occupied commercial property loan), the loan request will be denied.

With good credit and at least 10% to 20% down payment, you should be able to secure some form of financing. Your company's current bank may be the place to start since you have a history with them. To find more options and competitive rates, consider commercial brokerage firms, which specialize in matching commercial real estate buyers with commercial lenders.

Finally, you need to know your financial risk and decrease it whenever possible. For example, a multi-tenant building is almost always a safer bet than a single-tenant option, since it's unlikely that all your tenants will depart at the same time. Also, several pre-existing tenants with long-term leases will make getting a loan an easier sell than trying to pitch the bank on financing a vacant, single-tenant building that's not currently producing income. Knowing your risks and taking steps to mitigating them may make the difference between a continual financial burden and a sizeable financial gain.