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Investing in Commercial Real Estate
1
INVESTING IN
COMMERCIAL
REAL ESTATE
Investing in Commercial Real Estate
Investing in
Commercial
Real Estate
2
Investing in Commercial Real Estate
ALL RIGHTS RESERVED. No part of this report may be modified or altered in any
form whatsoever, electronic, or mechanical, including photocopying, recording, or by
any informational storage or retrieval system without express written, dated and
signed permission from the author.
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in this report may be affiliate links which means that I earn money if you choose to
buy from that vendor at some point in the near future. I do not choose which products
and services to promote based upon which pay me the most, I choose based upon my
decision of which I would recommend to a dear friend. You will never pay more for an
item by clicking through my affiliate link, and, in fact, may pay less since I negotiate
special offers for my readers that are not available elsewhere.
DISCLAIMER AND/OR LEGAL NOTICES: The information presented herein
represents the view of the author as of the date of publication. Because of the rate
with which conditions change, the author reserves the right to alter and update his
opinion based on the new conditions. The report is for informational purposes only.
While every attempt has been made to verify the information provided in this report,
neither the author nor his affiliates/partners assume any responsibility for errors,
inaccuracies or omissions. Any slights of people or organizations are unintentional. If
advice concerning legal or related matters is needed, the services of a fully qualified
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or accounting advice. You should be aware of any laws which govern business
transactions or other business practices in your country and state. Any reference to
any person or business whether living or dead is purely coincidental.
© Copyright
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Investing in Commercial Real Estate
Table of Contents
Introduction 5
..................................................................................................................
Advantages of Commercial Real Estate 7
...........................................................
Commercial Real Estate Investment Opportunities 10
...............................
Understand the Players 14
.........................................................................................
Learn the Lingo 17
..........................................................................................................
How to Analyze a Deal 20
...........................................................................................
Financing Commercial Real Estate 23
..................................................................
Strategies to Increase Profits 28
.............................................................................
The Most Critical Principles for Success 31
.......................................................
Getting Started 33
..........................................................................................................
Conclusion 36
...................................................................................................................
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Investing in Commercial Real Estate
Introduction
Many investors believe that all commercial real estate is
too complicated for them. Another common belief is
that you need a million dollars to get started. Neither is
true. It’s possible to invest in commercial real estate with
zero investing experience and an average salary.
Commercial real estate can be a safer and easier
investment than single family homes.
Commercial real estate encompasses a wider range of
properties than many beginning investors realize.
For our purposes, commercial real estate meets two
requirements:
1. Land and improvements purchased with the
intention of providing profit. The profit can be
derived from either leasing income or capital gains
at the time of sale.
2. Not a residential property of four units or less.
Single-family homes may meet the previous
requirement, but do meet this requirement.
Duplexes may be good real estate investments, but
are not considered commercial property.
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Investing in Commercial Real Estate
Avoid letting your preconceived notions get in the way
of investing in commercial properties. Commercial real
estate can be an excellent business for those with the
interest to learn the necessary information and steps.
“In the real estate business, you learn more about people, and you
learn more about community issues, you learn more about life,
you learn more about the impact of government, probably
than any other profession that I know of.”
- Johnny Isakson
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Investing in Commercial Real Estate
Advantages of
Commercial Real Estate
Any type of real estate has the potential to be a good
investment opportunity. Certain types of commercial
investments are riskier than others, but commercial
properties can offer greater financial rewards than
investing in smaller residential properties.
Commercial real estate has several advantages over
residential investing activities:
1. There’s much less competition. There are many
homebuyers competing for single-family homes.
Most real estate investors are more comfortable with
smaller residential properties. If you can get over
your discomfort, you’ll find there’s less competition
for commercial properties.
2. Significantly higher income opportunity. Leasing
commercial real estate is much higher in cost per
square foot than found in residential real estate.
❖ Many single-family properties rent for less than
50 cents per square foot.
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Investing in Commercial Real Estate
❖ An office in a high-rise building might cost over
$100 per square foot.
❖ Single family properties typically return 1-4% on
an annual basis.
❖ Commercial properties return an average of
6-12%.
3. The risk of vacancies is lower. If you’re ever owned
rental homes, a vacancy can be devastating. A few
months without a tenant can be quite expensive.
However, a vacancy in a 25-unit apartment building is
only a loss of 4% of your rental income.
4. Prices are easier to evaluate. Commercial real estate
prices are normally based the income they provide. An
office building, shopping center, or apartment
building is priced as a business. Businesses are priced
on income and profit. Residential real estate prices
are based on several other factors, including how
desirable the property is to any interested buyer.
5. Sellers are more flexible and less emotional. A
piece of commercial real estate is a business. By
default, the owners are business people.
Homeowners are more emotional when making
decisions regarding the sale of their home.
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Investing in Commercial Real Estate
Commercial real estate owners view everything as a
business decision.
❖ Commercial real estate owners can also be very
flexible on price and terms. Everything is up for
negotiation.
6. More potential for capital gains. There are
commercial properties available that cost over $100
million. A 10% appreciation on $100 million sure
beats 10% of $100,000. Larger investments have the
potential to provide larger returns.
Commercial investing can overcome many of the
limitations of investing in single-family homes.
Commercial properties are easier to appraise, the
vacancy risk is lower, and the potential for large gains is
greater. Consider these advantages before deciding on
whether or not to pursue these investing opportunities.
“Now, one thing I tell everyone is learn about real estate.
Repeat after me: real estate provides the highest returns,
the greatest values and the least risk.”
- Armstrong Williams
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Investing in Commercial Real Estate
Commercial Real Estate
Investment Opportunities
Remember that commercial real estate is purchased
with the intention of making money. It also excludes
smaller residential properties. Residential properties
must have at least five units to be considered commercial
property. Renting a home or duplex doesn’t qualify.
Several common types of property qualify as
commercial properties:
1. Retail shopping. This is the type of property most
beginning investors envision when considering
commercial property.
❖ Strip mall
❖ Large shopping center
❖ Beauty salon
❖ Gas station
❖ Any other retail property. It can be a single unit,
such as a stand-alone flower shop.
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Investing in Commercial Real Estate
❖ Even larger stores such as Walmart often lease
their buildings from someone else.
2. Apartment buildings with five units or more. Few
of us haven’t lived in a large apartment complex at
some point. This category includes smaller buildings
with several units to large, multi-building complexes
that house 1,000 people or more.
3. Office buildings. Whether small or large, any office
building satisfies the requirements of a commercial
property.
4. Hotels, motels, resorts. These larger properties can
generate a lot of income, but also require a lot of
overhead, including several employees.
5. Medical buildings. Your doctor or dentist may be in
such a building.
6. Warehouses. All the products you see in the stores
have to be stored somewhere before shipping.
7. Mobile home parks. Mobile home parks are another
type of commercial property. The tenants pay rent
for the lot. Some parks also rent the mobile homes
themselves, too. Campgrounds could also be
considered commercial property.
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Investing in Commercial Real Estate
8. Self-Storage Facilities. If you’ve ever decided your
garage was too full, you might have used the services
of a self-storage facility. Fortunately, many people
have more things than they can store at home.
9. Industrial property. This could be a manufacturing
facility or any type of industrial property. What’s the
difference between a retail property and an
industrial property? Retail properties are in the
business of selling a product or service directly to the
average consumer. Retail properties also have
customers on site.
❖ Industrial properties don’t allow the general
public on site.
You can probably think of other types of commercial
properties:
❖ Private airport
❖ Senior facilities
❖ Ranch
❖ Farm
❖ Movie theatre
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Investing in Commercial Real Estate
❖ Private cemetery
❖ Bowling alley
Commercial properties are very common. There’s little
reason for the beginning investor to feel intimidated. It’s
easy to see that some types of property require more
financing or expertise than others. Start with a type of
property that you understand. There’s something for
every type of investor.
“Commercial real estate always trails residential, and as
residential growth flourishes, shopping centers flourish
and service the communities, and jobs come out.”
- Johnny Isakson
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Investing in Commercial Real Estate
Understand the Players
It’s necessary to understand the players if you want to
understand the game. No one can invest in commercial
real estate without the assistance of experts. Finding the
right people to assist in your investing activities is part
of becoming successful. These experts can make the
process much smoother and keep you out of trouble.
Commercial real estate investments can require
more experts than simple residential investment
activities:
1. Real estate brokers. Commercial real estate brokers
specialize in commercial real estate. Commercial
brokers tend to be more experienced and have more
knowledge than the average residential broker.
2. Developers. Donald Trump is a well-known real
estate developer. These are the people that start with
an idea and make it happen. The person that built the
apartment complex you’re considering as an
investment is a real estate developer.
❖ Most developers stick with a particular type of
property, such as shopping malls, resorts, or
apartment buildings.
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Investing in Commercial Real Estate
3. Property managers. A shopping mall, apartment
complex, or large office building requires
management. You may be able to manage smaller
commercial properties yourself, but larger properties
can require a team of people, some of which need a
high level of expertise. Consider a company that
specializes in providing real estate management
services.
4. Direct lenders. This is the type of financial institution
most of us use for our personal banking and home
loans.
5. Financial Intermediaries. Commercial banks and
institutions that act as intermediaries between direct
lenders and investors are financial intermediaries.
Of course you still have many of the same people found
in more conventional real estate transactions, though
many are specialized. These include:
❖ Inspectors
❖ Insurance agents
❖ Appraisers
❖ Attorneys
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Investing in Commercial Real Estate
❖ Accountants
A commercial property is a business and requires more
experts than a simple home purchase transaction.
Commercial real estate differs enough that a unique
group of experts is necessary. Fortunately, these experts
are readily available to anyone that needs their services.
“Certainly the advent of technology and electronic commerce
has had an immense impact on the real estate industry.”
- Michael Oxley
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Investing in Commercial Real Estate
Learn the Lingo
Those in commercial real estate have their own
vocabulary. It’s also a bit of an exclusive community. One
way to convince the players in your area that you’re one
of them is to throw around the right terms. If you sound
like a single-family home investor, you might not be
taken seriously.
These terms also form the basis of your property
evaluation. Understanding these terms will allow you to
put your numbers to work and compare different
investment opportunities.
The terms that every commercial investor should
know:
1. Vacancy Rate = number of vacancies / number of
units. Ten vacancies in a 500-unit apartment building
would result in a vacancy rate of 2%.
2. Effective gross Income = gross income - vacancy.
Vacancy = vacancy rate x the cost of a vacancy. The
cost of a vacancy is the lost rental income.
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Investing in Commercial Real Estate
3. Operating Expenses. This includes all the expenses,
but not the mortgage. Taxes, insurance, salaries, and
so on are part of the operating expenses.
4. Net Operating Income or NOI. This is the gross
income minus the operating expenses.
5. Debt service is the amount paid over a year on the
mortgage.
6. Cash Flow. Cash flow = gross income – operating
expenses – debt service.
7. Capitalization Rate = NOI / sales price. This is one
of the most important values to the commercial real
estate investor. It’s a measure of the profitability of
the property. It’s the amount of income you receive
relative to the cost of the investment if you paid cash
for the investment. Debt servicing and income taxes
are not included in the cap rate.
8. Cash-on-Cash Return. This is the annual cash flow
divided by the down payment. It’s how much cash you
receive relative the amount of cash you have in the
deal.
Understand and use these terms when talking to
brokers, sellers, and anyone else connected to your
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Investing in Commercial Real Estate
deals or the commercial real estate industry. You’ll show
that you’re an insider and be taken more seriously. You’ll
also grow the confidence needed to have long-term
success!
“In any market, in any country, there are developers who make
money. So I say all of this doom and gloom, but there will
always be people who make money, because people
always want homes.”
- Sarah Beeny
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Investing in Commercial Real Estate
How to Analyze a Deal
You’ve found what looks like a good deal. How do you
analyze it? There are numerous ways to evaluate
commercial properties. Entire textbooks have been
dedicated to the topic. Assuming you haven’t bitten off
more than you can chew, there is a simple way to get
started.
The most important issue is the cash flow!
The initial assessment of any commercial property is
very simple:
1. Determine the revenue for the property. This is all
the income the property generates. For many
commercial properties, it’s the total rents collected
over the entire year.
❖ Avoid basing your calculation on 0% vacancy. Take
a look at the historical numbers. What are the
vacancy rates for similar properties in the area?
❖ Are the current rents reasonable? It’s often
possible to raise the rents if the property has
been owned by the same person for a long period
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Investing in Commercial Real Estate
of time. However, consider the length and terms
of the leases already in place.
❖ This value is also called the “gross income.”
2. Determine the expenses. Exclude the mortgage, but
include everything else. These are considered the
“operating expenses.”
❖ Taxes
❖ Repairs and maintenance
❖ Insurance
❖ Salaries
❖ Supplies
❖ Marketing
❖ Utilities
❖ Management services
❖ And any other expenses
3. Calculate the cost of servicing the debt. Remember
that you’ll have to make a monthly mortgage payment
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Investing in Commercial Real Estate
unless you’re able to pay for the property from your
own pocket. Consider your down payment and the
current rates for a commercial mortgage.
4. Subtract the expenses and the debt from the
revenue. Work on an annual basis and determine the
cash flow for the property.
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Investing in Commercial Real Estate
Financing Commercial
Real Estate
Unless you have money trees in your backyard or a
wealthy uncle, you’re likely to need financing to
purchase your first commercial property. Residential
and commercial financing are similar, but not identical. If
you understand one, it’s a simple matter to understand
the other.
There are several differences between residential
loans and commercial loans:
1. Residential loans are most often made to
individuals. Commercial mortgages are primarily
given to business entities, such as builders,
partnerships, and developers. It’s entirely possible to
purchase your personal home in the name of an LLC,
but it’s not common.
❖ Businesses can have their own credit histories
and scores. If you don’t have a business entity
with a credit history, you can rely on your own
credit.
2. Commercial loans have higher interest rates and
fees. You’ll pay more in interest and fees for a
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Investing in Commercial Real Estate
commercial loan than you will for a residential loan.
Some of the costs must be paid up front. Other costs
recur on an annual basis.
❖ Ensure these fees are included in your
calculations.
3. Commercial loans have a shorter payback period.
Your conventional home loan can have a payback
period of 30 years or more. Commercial loans range
from just a few years to 20 years.
4. Commercial loans have harsher prepayment
penalties. You home loan also has prepayment
penalties, but these penalties are only in effect for a
short period of time. Commercial loans can have
several types of penalties:
❖ The terms of the loan might declare that the loan
cannot be paid off before a certain date.
❖ A prepayment penalty is determined by
multiplying the remaining balance by a
predetermined percentage.
❖ An amount of interest is guaranteed by the terms
of the loan.
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Investing in Commercial Real Estate
5. Amortization is handled differently. A home
mortgage is normally amortized over the life of the
loan. If you have a 30-year loan, you have 360 equal
payments and the loan balance is zero at the end of
the loan payback period.
❖ Commercial loans usually have a longer
amortization period than the length of the loan.
You might make payments on the loan as if the
loan were 30 years, but the loan is actually due in
15 years. That means your last payment will be a
large balloon payment.
6. Commercial loans frequently require a larger
down payment. In some circumstances, it’s possible
to acquire a home mortgage with no money down.
❖ Commercial loans frequently require from
20-35% down.
7. There is no private mortgage insurance in
commercial lending. One of the reasons larger down
payments are required is the lack of private mortgage
insurance. The only insurance a lender has against
default is the collateral in the real estate.
8. Commercial lenders consider cash flow. Debt-
service coverage ratio is another important term to
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Investing in Commercial Real Estate
know. This is the NOI divided by the annual debt
service. Lenders favor loan applications with a debt-
service coverage ratio of 1.25 or more. This means
that the NOI is enough to cover 125% of the debt
payments.
Commercial loans are similar to home loans, with a
twist. As with any financing, use all the numbers to make
your final decision. Commercial loans have shorter
terms, higher interest rates, and higher prepayment
penalties. The process for determining whether a loan
will be approved is also different.
Commercial real estate lenders consider 3 criteria in
lending decisions:
1. Creditworthiness. As with most other loans, your
credit history and credit score play a big part.
Current industry standards include:
❖ Credit score of 660 or greater
❖ No bankruptcies in the last 7 years
❖ No current tax issues, liens, or judgments
❖ No foreclosures or short sales in the last 3 years
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Investing in Commercial Real Estate
2. Collateral. The collateral is the property in question.
If the terms of the loan aren’t being met, the lender
can exercise an acceleration clause and begin the
foreclosure process.
❖ Lease payments are also assigned to the lender to
provide additional security. This means that the
lender is paid first.
❖ It’s possible to pledge other assets as collateral.
These assets can be personal or business assets
and can include receivables and contracts.
3. Cash flow. Remember that the debt-service
coverage should be at least 1.25.
Commercial real estate financing is similar to financing
for conventional home ownership. You must have good
credit and the means to pay back the loan. In commercial
situations, the ability of the property to service the loan
is also considered. A commercial property is a business,
and the quality of that business is part of the loan
approval process.
“Real estate is an imperishable asset, ever increasing in value. It is
the most solid security that human ingenuity has devised. It is
the basis of all security and about the only indestructible security.”
- Russell Sage, American Financier and Politician
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Investing in Commercial Real Estate
Strategies to Increase Profits
There is no strategy that works in all situations. The best
strategy to employ will depend on the type of property
and the unique circumstances. For example, some
apartment complexes can be converted to condos while
others cannot. Raw land is difficult to lease to multiple
tenants without improvements.
1. Raw land. There are a few ways to approach an
investment in raw land.
❖ Lease the land. Land can be leased to farmers,
lumber companies, hunters, and even to
companies that wish to add improvements.
❖ Improve it. You could build homes, apartments, a
shopping center, or an amusement park.
❖ Raw land can require additional time and money
to generate income. The loan terms for raw land
often reflect this fact. Expect your lender to
require a large down payment.
2. Apartment buildings. There are two primary ways to
increase income from apartments.
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Investing in Commercial Real Estate
❖ Raise rents. Tenants expect that rents will
increase each year, so raise those rents.
Decreasing vacancies is another way to increase
rents.
❖ Convert. Many apartment buildings can be
converted to condominiums. It’s possible to make
a lot of money this way, but zoning approval can
also be required.
3. Office buildings. Again, raise the rents over time and
decrease vacancies.
While there are many complicated ways to increase the
income and value of commercial properties, the basics
are always the same.
❖ Raise the rents
❖ Decrease vacancies
❖ Convert
❖ Improve
❖ Accumulate equity
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Investing in Commercial Real Estate
There’s no reason to overcomplicate things until your
investments become more sophisticated. Find ways to
increase revenues without increasing costs excessively.
Consider converting your property to a higher use.
“Real estate cannot be lost or stolen, nor can it be carried away.
Purchased with common sense, paid for in full, and managed with
reasonable care, it is about the safest investment in the world.”
- Franklin D. Roosevelt
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Investing in Commercial Real Estate
The Most Critical
Principles for Success
As with any endeavor, there are a few key principles to
keep in mind. While there are no guarantees in real
estate investing, there are ways to stack the odds in your
favor. Keep the most important factors in mind at all
times.
Four factors can increase the likelihood of success:
1. Search for a great price or great terms. If possible,
find a deal that offers both. Finding a good deal in
commercial real estate is much more challenging
than when shopping for your personal home.
However, most commercial deals are fair. It’s all in the
numbers. Ensure that the numbers are accurate.
2. Avoid costly early mistakes. An experienced
investor with $10 million in her bank account can
absorb a mistake or two. Those with more moderate
means have less of a cushion.
❖ Start small. Do a small deal. Learn how to evaluate
a property and find the best financing. Get to
know the people behind the deals. If your first
31
Investing in Commercial Real Estate
deal is profitable, be a little bolder the next time.
There’s no rush.
3. Stick to reasonable capitalization rate properties.
Reasonable can be defined as 8-15%. High cap
properties are often in poor areas and represent a
higher risk. Properties with low cap rates are low risk,
but the returns are also low.
4. Purchase properties with a cash-on-cash return of
at least 10%. This is a measure of how long it takes to
get your cash back in your pocket. If you put down
$50,000 on a property, how many years will it take
the cash flow to return that down payment?
Be honest with yourself when compiling your numbers
and evaluating the property. It can be tempting to cheat
a little when you like a property. Avoid the temptation!
Be objective and allow the numbers to guide you. Be
patient.
“Ninety percent of all millionaires become so through owning
real estate. More money has been made in real estate than in
all industrial investments combined. The wise young man
or wage earner of today invests his money in real estate.”
- Andrew Carnegie
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Investing in Commercial Real Estate
Getting Started
You’re ready to begin your commercial investing career.
How do you get started? Making offers on properties
isn’t the first step. The first step consists of educating
yourself and making a few key decisions.
Start your commercial real estate investing career
intelligently:
1. Determine the type of commercial real estate that
interests you. The most common options for
beginning investors are residential, office, and retail.
Which option most appeals to you? What
opportunities are available in your area?
❖ It’s important to focus your attention. Become an
expert on one type of commercial real estate and
do the necessary work. Build on your experience.
Changing from one type of investment to another
would be a mistake. Learn from each investment
you make.
2. Begin educating yourself on the local market.
Become an expert on your market. Dig into the local
listings and make yourself aware of what’s going on.
33
Investing in Commercial Real Estate
What parts of town are most desirable? Where are
rents the highest? Lowest?
❖ Drive around town and look at listings. Get a feel
for your local market.
3. Make contact with a local commercial real estate
broker. Offer to buy them lunch and talk shop. Get
recommendations for the various experts you’ll need
along the way.
❖ Attorney
❖ Title company
❖ Accountant
4. Investigate your financing options. Take a long and
hard look at your credit rating. When your credit is in
order, start shopping around. Commercial real estate
owners are often willing to offer creative financing
options. Investigate all the possibilities.
❖ Speak with your broker. She will know the local
customs and lenders. She may also be able to
suggest alternate sources of financing.
34
Investing in Commercial Real Estate
5. Fully investigate each property that interests you.
Use your skills and analyze each deal. Remain
objective and do your best to get an accurate picture
of each possible deal. Ask lots of questions. Buying
real estate carries big responsibilities. Do your due
diligence.
6. Make offers. When you’ve found a good deal that
appeals to you, rely on the advice of your broker and
begin making offers.
7. Close the deal. It’s time for the money to change
hands. The closing is similar to any other real estate
closing you’ve attended, but a little more
complicated. Your team of experts will guide you
through the process.
Those are the basic steps to get you started. Of course,
it’s not always that simple. It will be necessary to flesh
out your knowledge in several areas. After choosing a
type of property for your specialty, get to work and
educate yourself!
“A funny thing happens in real estate. When it comes back,
it comes back up like gangbusters.”
- Barbara Corcoran
35
Investing in Commercial Real Estate
Conclusion
There is much more to learn. Commercial real estate
investing requires quite a bit of knowledge. We’ve only
touched on the highlights. For example, if you’re going
to collect rents or lease payments, it’s necessary to be
an expert on leases or have the proper attorney on your
team.
Commercial real estate has several advantages over
small residential real estate investments. If you’ve
always believed that commercial real estate is too
complicated or only suitable for wealthy investors,
reconsider. There are commercial investments suitable
for any investor with good credit and a down payment.
Do your due diligence for each deal and, for your best
results, stick with investments and properties that you
understand.
36

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Investing-In-Commercial-Real-Estate-2024

  • 1. Investing in Commercial Real Estate 1 INVESTING IN COMMERCIAL REAL ESTATE
  • 2. Investing in Commercial Real Estate Investing in Commercial Real Estate 2
  • 3. Investing in Commercial Real Estate ALL RIGHTS RESERVED. No part of this report may be modified or altered in any form whatsoever, electronic, or mechanical, including photocopying, recording, or by any informational storage or retrieval system without express written, dated and signed permission from the author. AFFILIATE DISCLAIMER. The short, direct, non-legal version is this: Some of the links in this report may be affiliate links which means that I earn money if you choose to buy from that vendor at some point in the near future. I do not choose which products and services to promote based upon which pay me the most, I choose based upon my decision of which I would recommend to a dear friend. You will never pay more for an item by clicking through my affiliate link, and, in fact, may pay less since I negotiate special offers for my readers that are not available elsewhere. DISCLAIMER AND/OR LEGAL NOTICES: The information presented herein represents the view of the author as of the date of publication. Because of the rate with which conditions change, the author reserves the right to alter and update his opinion based on the new conditions. The report is for informational purposes only. While every attempt has been made to verify the information provided in this report, neither the author nor his affiliates/partners assume any responsibility for errors, inaccuracies or omissions. Any slights of people or organizations are unintentional. If advice concerning legal or related matters is needed, the services of a fully qualified professional should be sought. This report is not intended for use as a source of legal or accounting advice. You should be aware of any laws which govern business transactions or other business practices in your country and state. Any reference to any person or business whether living or dead is purely coincidental. © Copyright 3
  • 4. Investing in Commercial Real Estate Table of Contents Introduction 5 .................................................................................................................. Advantages of Commercial Real Estate 7 ........................................................... Commercial Real Estate Investment Opportunities 10 ............................... Understand the Players 14 ......................................................................................... Learn the Lingo 17 .......................................................................................................... How to Analyze a Deal 20 ........................................................................................... Financing Commercial Real Estate 23 .................................................................. Strategies to Increase Profits 28 ............................................................................. The Most Critical Principles for Success 31 ....................................................... Getting Started 33 .......................................................................................................... Conclusion 36 ................................................................................................................... 4
  • 5. Investing in Commercial Real Estate Introduction Many investors believe that all commercial real estate is too complicated for them. Another common belief is that you need a million dollars to get started. Neither is true. It’s possible to invest in commercial real estate with zero investing experience and an average salary. Commercial real estate can be a safer and easier investment than single family homes. Commercial real estate encompasses a wider range of properties than many beginning investors realize. For our purposes, commercial real estate meets two requirements: 1. Land and improvements purchased with the intention of providing profit. The profit can be derived from either leasing income or capital gains at the time of sale. 2. Not a residential property of four units or less. Single-family homes may meet the previous requirement, but do meet this requirement. Duplexes may be good real estate investments, but are not considered commercial property. 5
  • 6. Investing in Commercial Real Estate Avoid letting your preconceived notions get in the way of investing in commercial properties. Commercial real estate can be an excellent business for those with the interest to learn the necessary information and steps. “In the real estate business, you learn more about people, and you learn more about community issues, you learn more about life, you learn more about the impact of government, probably than any other profession that I know of.” - Johnny Isakson 6
  • 7. Investing in Commercial Real Estate Advantages of Commercial Real Estate Any type of real estate has the potential to be a good investment opportunity. Certain types of commercial investments are riskier than others, but commercial properties can offer greater financial rewards than investing in smaller residential properties. Commercial real estate has several advantages over residential investing activities: 1. There’s much less competition. There are many homebuyers competing for single-family homes. Most real estate investors are more comfortable with smaller residential properties. If you can get over your discomfort, you’ll find there’s less competition for commercial properties. 2. Significantly higher income opportunity. Leasing commercial real estate is much higher in cost per square foot than found in residential real estate. ❖ Many single-family properties rent for less than 50 cents per square foot. 7
  • 8. Investing in Commercial Real Estate ❖ An office in a high-rise building might cost over $100 per square foot. ❖ Single family properties typically return 1-4% on an annual basis. ❖ Commercial properties return an average of 6-12%. 3. The risk of vacancies is lower. If you’re ever owned rental homes, a vacancy can be devastating. A few months without a tenant can be quite expensive. However, a vacancy in a 25-unit apartment building is only a loss of 4% of your rental income. 4. Prices are easier to evaluate. Commercial real estate prices are normally based the income they provide. An office building, shopping center, or apartment building is priced as a business. Businesses are priced on income and profit. Residential real estate prices are based on several other factors, including how desirable the property is to any interested buyer. 5. Sellers are more flexible and less emotional. A piece of commercial real estate is a business. By default, the owners are business people. Homeowners are more emotional when making decisions regarding the sale of their home. 8
  • 9. Investing in Commercial Real Estate Commercial real estate owners view everything as a business decision. ❖ Commercial real estate owners can also be very flexible on price and terms. Everything is up for negotiation. 6. More potential for capital gains. There are commercial properties available that cost over $100 million. A 10% appreciation on $100 million sure beats 10% of $100,000. Larger investments have the potential to provide larger returns. Commercial investing can overcome many of the limitations of investing in single-family homes. Commercial properties are easier to appraise, the vacancy risk is lower, and the potential for large gains is greater. Consider these advantages before deciding on whether or not to pursue these investing opportunities. “Now, one thing I tell everyone is learn about real estate. Repeat after me: real estate provides the highest returns, the greatest values and the least risk.” - Armstrong Williams 9
  • 10. Investing in Commercial Real Estate Commercial Real Estate Investment Opportunities Remember that commercial real estate is purchased with the intention of making money. It also excludes smaller residential properties. Residential properties must have at least five units to be considered commercial property. Renting a home or duplex doesn’t qualify. Several common types of property qualify as commercial properties: 1. Retail shopping. This is the type of property most beginning investors envision when considering commercial property. ❖ Strip mall ❖ Large shopping center ❖ Beauty salon ❖ Gas station ❖ Any other retail property. It can be a single unit, such as a stand-alone flower shop. 10
  • 11. Investing in Commercial Real Estate ❖ Even larger stores such as Walmart often lease their buildings from someone else. 2. Apartment buildings with five units or more. Few of us haven’t lived in a large apartment complex at some point. This category includes smaller buildings with several units to large, multi-building complexes that house 1,000 people or more. 3. Office buildings. Whether small or large, any office building satisfies the requirements of a commercial property. 4. Hotels, motels, resorts. These larger properties can generate a lot of income, but also require a lot of overhead, including several employees. 5. Medical buildings. Your doctor or dentist may be in such a building. 6. Warehouses. All the products you see in the stores have to be stored somewhere before shipping. 7. Mobile home parks. Mobile home parks are another type of commercial property. The tenants pay rent for the lot. Some parks also rent the mobile homes themselves, too. Campgrounds could also be considered commercial property. 11
  • 12. Investing in Commercial Real Estate 8. Self-Storage Facilities. If you’ve ever decided your garage was too full, you might have used the services of a self-storage facility. Fortunately, many people have more things than they can store at home. 9. Industrial property. This could be a manufacturing facility or any type of industrial property. What’s the difference between a retail property and an industrial property? Retail properties are in the business of selling a product or service directly to the average consumer. Retail properties also have customers on site. ❖ Industrial properties don’t allow the general public on site. You can probably think of other types of commercial properties: ❖ Private airport ❖ Senior facilities ❖ Ranch ❖ Farm ❖ Movie theatre 12
  • 13. Investing in Commercial Real Estate ❖ Private cemetery ❖ Bowling alley Commercial properties are very common. There’s little reason for the beginning investor to feel intimidated. It’s easy to see that some types of property require more financing or expertise than others. Start with a type of property that you understand. There’s something for every type of investor. “Commercial real estate always trails residential, and as residential growth flourishes, shopping centers flourish and service the communities, and jobs come out.” - Johnny Isakson 13
  • 14. Investing in Commercial Real Estate Understand the Players It’s necessary to understand the players if you want to understand the game. No one can invest in commercial real estate without the assistance of experts. Finding the right people to assist in your investing activities is part of becoming successful. These experts can make the process much smoother and keep you out of trouble. Commercial real estate investments can require more experts than simple residential investment activities: 1. Real estate brokers. Commercial real estate brokers specialize in commercial real estate. Commercial brokers tend to be more experienced and have more knowledge than the average residential broker. 2. Developers. Donald Trump is a well-known real estate developer. These are the people that start with an idea and make it happen. The person that built the apartment complex you’re considering as an investment is a real estate developer. ❖ Most developers stick with a particular type of property, such as shopping malls, resorts, or apartment buildings. 14
  • 15. Investing in Commercial Real Estate 3. Property managers. A shopping mall, apartment complex, or large office building requires management. You may be able to manage smaller commercial properties yourself, but larger properties can require a team of people, some of which need a high level of expertise. Consider a company that specializes in providing real estate management services. 4. Direct lenders. This is the type of financial institution most of us use for our personal banking and home loans. 5. Financial Intermediaries. Commercial banks and institutions that act as intermediaries between direct lenders and investors are financial intermediaries. Of course you still have many of the same people found in more conventional real estate transactions, though many are specialized. These include: ❖ Inspectors ❖ Insurance agents ❖ Appraisers ❖ Attorneys 15
  • 16. Investing in Commercial Real Estate ❖ Accountants A commercial property is a business and requires more experts than a simple home purchase transaction. Commercial real estate differs enough that a unique group of experts is necessary. Fortunately, these experts are readily available to anyone that needs their services. “Certainly the advent of technology and electronic commerce has had an immense impact on the real estate industry.” - Michael Oxley 16
  • 17. Investing in Commercial Real Estate Learn the Lingo Those in commercial real estate have their own vocabulary. It’s also a bit of an exclusive community. One way to convince the players in your area that you’re one of them is to throw around the right terms. If you sound like a single-family home investor, you might not be taken seriously. These terms also form the basis of your property evaluation. Understanding these terms will allow you to put your numbers to work and compare different investment opportunities. The terms that every commercial investor should know: 1. Vacancy Rate = number of vacancies / number of units. Ten vacancies in a 500-unit apartment building would result in a vacancy rate of 2%. 2. Effective gross Income = gross income - vacancy. Vacancy = vacancy rate x the cost of a vacancy. The cost of a vacancy is the lost rental income. 17
  • 18. Investing in Commercial Real Estate 3. Operating Expenses. This includes all the expenses, but not the mortgage. Taxes, insurance, salaries, and so on are part of the operating expenses. 4. Net Operating Income or NOI. This is the gross income minus the operating expenses. 5. Debt service is the amount paid over a year on the mortgage. 6. Cash Flow. Cash flow = gross income – operating expenses – debt service. 7. Capitalization Rate = NOI / sales price. This is one of the most important values to the commercial real estate investor. It’s a measure of the profitability of the property. It’s the amount of income you receive relative to the cost of the investment if you paid cash for the investment. Debt servicing and income taxes are not included in the cap rate. 8. Cash-on-Cash Return. This is the annual cash flow divided by the down payment. It’s how much cash you receive relative the amount of cash you have in the deal. Understand and use these terms when talking to brokers, sellers, and anyone else connected to your 18
  • 19. Investing in Commercial Real Estate deals or the commercial real estate industry. You’ll show that you’re an insider and be taken more seriously. You’ll also grow the confidence needed to have long-term success! “In any market, in any country, there are developers who make money. So I say all of this doom and gloom, but there will always be people who make money, because people always want homes.” - Sarah Beeny 19
  • 20. Investing in Commercial Real Estate How to Analyze a Deal You’ve found what looks like a good deal. How do you analyze it? There are numerous ways to evaluate commercial properties. Entire textbooks have been dedicated to the topic. Assuming you haven’t bitten off more than you can chew, there is a simple way to get started. The most important issue is the cash flow! The initial assessment of any commercial property is very simple: 1. Determine the revenue for the property. This is all the income the property generates. For many commercial properties, it’s the total rents collected over the entire year. ❖ Avoid basing your calculation on 0% vacancy. Take a look at the historical numbers. What are the vacancy rates for similar properties in the area? ❖ Are the current rents reasonable? It’s often possible to raise the rents if the property has been owned by the same person for a long period 20
  • 21. Investing in Commercial Real Estate of time. However, consider the length and terms of the leases already in place. ❖ This value is also called the “gross income.” 2. Determine the expenses. Exclude the mortgage, but include everything else. These are considered the “operating expenses.” ❖ Taxes ❖ Repairs and maintenance ❖ Insurance ❖ Salaries ❖ Supplies ❖ Marketing ❖ Utilities ❖ Management services ❖ And any other expenses 3. Calculate the cost of servicing the debt. Remember that you’ll have to make a monthly mortgage payment 21
  • 22. Investing in Commercial Real Estate unless you’re able to pay for the property from your own pocket. Consider your down payment and the current rates for a commercial mortgage. 4. Subtract the expenses and the debt from the revenue. Work on an annual basis and determine the cash flow for the property. 22
  • 23. Investing in Commercial Real Estate Financing Commercial Real Estate Unless you have money trees in your backyard or a wealthy uncle, you’re likely to need financing to purchase your first commercial property. Residential and commercial financing are similar, but not identical. If you understand one, it’s a simple matter to understand the other. There are several differences between residential loans and commercial loans: 1. Residential loans are most often made to individuals. Commercial mortgages are primarily given to business entities, such as builders, partnerships, and developers. It’s entirely possible to purchase your personal home in the name of an LLC, but it’s not common. ❖ Businesses can have their own credit histories and scores. If you don’t have a business entity with a credit history, you can rely on your own credit. 2. Commercial loans have higher interest rates and fees. You’ll pay more in interest and fees for a 23
  • 24. Investing in Commercial Real Estate commercial loan than you will for a residential loan. Some of the costs must be paid up front. Other costs recur on an annual basis. ❖ Ensure these fees are included in your calculations. 3. Commercial loans have a shorter payback period. Your conventional home loan can have a payback period of 30 years or more. Commercial loans range from just a few years to 20 years. 4. Commercial loans have harsher prepayment penalties. You home loan also has prepayment penalties, but these penalties are only in effect for a short period of time. Commercial loans can have several types of penalties: ❖ The terms of the loan might declare that the loan cannot be paid off before a certain date. ❖ A prepayment penalty is determined by multiplying the remaining balance by a predetermined percentage. ❖ An amount of interest is guaranteed by the terms of the loan. 24
  • 25. Investing in Commercial Real Estate 5. Amortization is handled differently. A home mortgage is normally amortized over the life of the loan. If you have a 30-year loan, you have 360 equal payments and the loan balance is zero at the end of the loan payback period. ❖ Commercial loans usually have a longer amortization period than the length of the loan. You might make payments on the loan as if the loan were 30 years, but the loan is actually due in 15 years. That means your last payment will be a large balloon payment. 6. Commercial loans frequently require a larger down payment. In some circumstances, it’s possible to acquire a home mortgage with no money down. ❖ Commercial loans frequently require from 20-35% down. 7. There is no private mortgage insurance in commercial lending. One of the reasons larger down payments are required is the lack of private mortgage insurance. The only insurance a lender has against default is the collateral in the real estate. 8. Commercial lenders consider cash flow. Debt- service coverage ratio is another important term to 25
  • 26. Investing in Commercial Real Estate know. This is the NOI divided by the annual debt service. Lenders favor loan applications with a debt- service coverage ratio of 1.25 or more. This means that the NOI is enough to cover 125% of the debt payments. Commercial loans are similar to home loans, with a twist. As with any financing, use all the numbers to make your final decision. Commercial loans have shorter terms, higher interest rates, and higher prepayment penalties. The process for determining whether a loan will be approved is also different. Commercial real estate lenders consider 3 criteria in lending decisions: 1. Creditworthiness. As with most other loans, your credit history and credit score play a big part. Current industry standards include: ❖ Credit score of 660 or greater ❖ No bankruptcies in the last 7 years ❖ No current tax issues, liens, or judgments ❖ No foreclosures or short sales in the last 3 years 26
  • 27. Investing in Commercial Real Estate 2. Collateral. The collateral is the property in question. If the terms of the loan aren’t being met, the lender can exercise an acceleration clause and begin the foreclosure process. ❖ Lease payments are also assigned to the lender to provide additional security. This means that the lender is paid first. ❖ It’s possible to pledge other assets as collateral. These assets can be personal or business assets and can include receivables and contracts. 3. Cash flow. Remember that the debt-service coverage should be at least 1.25. Commercial real estate financing is similar to financing for conventional home ownership. You must have good credit and the means to pay back the loan. In commercial situations, the ability of the property to service the loan is also considered. A commercial property is a business, and the quality of that business is part of the loan approval process. “Real estate is an imperishable asset, ever increasing in value. It is the most solid security that human ingenuity has devised. It is the basis of all security and about the only indestructible security.” - Russell Sage, American Financier and Politician 27
  • 28. Investing in Commercial Real Estate Strategies to Increase Profits There is no strategy that works in all situations. The best strategy to employ will depend on the type of property and the unique circumstances. For example, some apartment complexes can be converted to condos while others cannot. Raw land is difficult to lease to multiple tenants without improvements. 1. Raw land. There are a few ways to approach an investment in raw land. ❖ Lease the land. Land can be leased to farmers, lumber companies, hunters, and even to companies that wish to add improvements. ❖ Improve it. You could build homes, apartments, a shopping center, or an amusement park. ❖ Raw land can require additional time and money to generate income. The loan terms for raw land often reflect this fact. Expect your lender to require a large down payment. 2. Apartment buildings. There are two primary ways to increase income from apartments. 28
  • 29. Investing in Commercial Real Estate ❖ Raise rents. Tenants expect that rents will increase each year, so raise those rents. Decreasing vacancies is another way to increase rents. ❖ Convert. Many apartment buildings can be converted to condominiums. It’s possible to make a lot of money this way, but zoning approval can also be required. 3. Office buildings. Again, raise the rents over time and decrease vacancies. While there are many complicated ways to increase the income and value of commercial properties, the basics are always the same. ❖ Raise the rents ❖ Decrease vacancies ❖ Convert ❖ Improve ❖ Accumulate equity 29
  • 30. Investing in Commercial Real Estate There’s no reason to overcomplicate things until your investments become more sophisticated. Find ways to increase revenues without increasing costs excessively. Consider converting your property to a higher use. “Real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care, it is about the safest investment in the world.” - Franklin D. Roosevelt 30
  • 31. Investing in Commercial Real Estate The Most Critical Principles for Success As with any endeavor, there are a few key principles to keep in mind. While there are no guarantees in real estate investing, there are ways to stack the odds in your favor. Keep the most important factors in mind at all times. Four factors can increase the likelihood of success: 1. Search for a great price or great terms. If possible, find a deal that offers both. Finding a good deal in commercial real estate is much more challenging than when shopping for your personal home. However, most commercial deals are fair. It’s all in the numbers. Ensure that the numbers are accurate. 2. Avoid costly early mistakes. An experienced investor with $10 million in her bank account can absorb a mistake or two. Those with more moderate means have less of a cushion. ❖ Start small. Do a small deal. Learn how to evaluate a property and find the best financing. Get to know the people behind the deals. If your first 31
  • 32. Investing in Commercial Real Estate deal is profitable, be a little bolder the next time. There’s no rush. 3. Stick to reasonable capitalization rate properties. Reasonable can be defined as 8-15%. High cap properties are often in poor areas and represent a higher risk. Properties with low cap rates are low risk, but the returns are also low. 4. Purchase properties with a cash-on-cash return of at least 10%. This is a measure of how long it takes to get your cash back in your pocket. If you put down $50,000 on a property, how many years will it take the cash flow to return that down payment? Be honest with yourself when compiling your numbers and evaluating the property. It can be tempting to cheat a little when you like a property. Avoid the temptation! Be objective and allow the numbers to guide you. Be patient. “Ninety percent of all millionaires become so through owning real estate. More money has been made in real estate than in all industrial investments combined. The wise young man or wage earner of today invests his money in real estate.” - Andrew Carnegie 32
  • 33. Investing in Commercial Real Estate Getting Started You’re ready to begin your commercial investing career. How do you get started? Making offers on properties isn’t the first step. The first step consists of educating yourself and making a few key decisions. Start your commercial real estate investing career intelligently: 1. Determine the type of commercial real estate that interests you. The most common options for beginning investors are residential, office, and retail. Which option most appeals to you? What opportunities are available in your area? ❖ It’s important to focus your attention. Become an expert on one type of commercial real estate and do the necessary work. Build on your experience. Changing from one type of investment to another would be a mistake. Learn from each investment you make. 2. Begin educating yourself on the local market. Become an expert on your market. Dig into the local listings and make yourself aware of what’s going on. 33
  • 34. Investing in Commercial Real Estate What parts of town are most desirable? Where are rents the highest? Lowest? ❖ Drive around town and look at listings. Get a feel for your local market. 3. Make contact with a local commercial real estate broker. Offer to buy them lunch and talk shop. Get recommendations for the various experts you’ll need along the way. ❖ Attorney ❖ Title company ❖ Accountant 4. Investigate your financing options. Take a long and hard look at your credit rating. When your credit is in order, start shopping around. Commercial real estate owners are often willing to offer creative financing options. Investigate all the possibilities. ❖ Speak with your broker. She will know the local customs and lenders. She may also be able to suggest alternate sources of financing. 34
  • 35. Investing in Commercial Real Estate 5. Fully investigate each property that interests you. Use your skills and analyze each deal. Remain objective and do your best to get an accurate picture of each possible deal. Ask lots of questions. Buying real estate carries big responsibilities. Do your due diligence. 6. Make offers. When you’ve found a good deal that appeals to you, rely on the advice of your broker and begin making offers. 7. Close the deal. It’s time for the money to change hands. The closing is similar to any other real estate closing you’ve attended, but a little more complicated. Your team of experts will guide you through the process. Those are the basic steps to get you started. Of course, it’s not always that simple. It will be necessary to flesh out your knowledge in several areas. After choosing a type of property for your specialty, get to work and educate yourself! “A funny thing happens in real estate. When it comes back, it comes back up like gangbusters.” - Barbara Corcoran 35
  • 36. Investing in Commercial Real Estate Conclusion There is much more to learn. Commercial real estate investing requires quite a bit of knowledge. We’ve only touched on the highlights. For example, if you’re going to collect rents or lease payments, it’s necessary to be an expert on leases or have the proper attorney on your team. Commercial real estate has several advantages over small residential real estate investments. If you’ve always believed that commercial real estate is too complicated or only suitable for wealthy investors, reconsider. There are commercial investments suitable for any investor with good credit and a down payment. Do your due diligence for each deal and, for your best results, stick with investments and properties that you understand. 36