Commercial real estate investing can be very rewarding for those who take the time and effort to approach it wisely, but it can be a trap for those who rush in without doing the proper homework.
Too often, investors rush into buying a property for all the wrong reasons – “it’s a good deal,” a “bargain opportunity” and the list goes on. Then they wonder what happened when the investment either falls flat or becomes a full time job.
If you are serious about building significant wealth from commercial property investment, you must have a proper investment strategy. This is a get rich slow business that requires patience, planning and persistence.
The key elements to any property investment strategy include:
Get your personal financial affairs in order and make sure they are geared towards building wealth, not paying off consumer debt. Also, check your credit rating to make sure it is in order.
Draw up a list of your criteria for property type, size and location. Be aware that each type of property requires a different set of skills to manage and offers varying rates of return. It is much easier to fit the property to your strengths rather than you try and change to fit the property.
Study your local market so you can quickly identify opportunities that are within your capacity to act on. It’s no use looking to invest in an area where you don’t have on the ground knowledge.
Be prepared to study and learn. Once you’ve spotted a possible deal, you need to be able to accurately value a property based on its condition, your return expectation, and your borrowing power. You need to understand why “what is it worth” is the wrong question to ask, and how to answer the right question “what is it worth to me?”
And last but not least, you need to learn how to structure deals and make offers too good to refuse.
When you have done this homework properly, you will be in a position to act decisively, reap the profits and keep them. Of course, you will need to consult regularly with your accountant on tax planning and asset protection, which are cornerstones of any wealth building plan.
Once your overall planning is done, the next step is to select your real estate team. You will need a good real estate agent, loan officer, tax advisor, and lawyer. These people are critical to your success because the investor with the best knowledge can quickly identify the properties to ignore and those worth considering.
Remember the old adage, “the quick and the dead” – the speed at which you can close a deal will give you the edge in any type of market. In addition, your advisors can point you in the right direction regarding finance, tax and legal issues.
Also, there is a good reason behind the catch cry, “location, location, value”. You want a return on your dollar so you are looking for a property that requires some attention so you can add value.
One strategy is to buy real estate in up-and-coming area with new developments or renovated properties. This makes it easy to attract and keep good tenants and leads to greater returns.
Another tactic to add value is to buy properties in solid locations but require some maintenance or upgrading, such as improving the aesthetic appeal of the building, thus instantly improving its value with little outlay.
In regard to financing, banks are the most obvious first lender, but commercial loans are not quite as simple as the more commonly known residential loans and you should always seek professional advice from your accountant and legal advisor.
You should also understand the various methods of financing, such as double closing, lease options, and contract for deed.
Double closing has attracted negative publicity lately, but only because it is misunderstood. This is a perfectly legal, moral and ethical method of trading that has been around for 100 years or more.
A double closing is simply two back-to-back closings wherein the proceeds from the second closing are used to fund the first closing. Both closings are done in escrow, so the “middleman” can buy and resell a property for profit without putting up their own cash.
The main downside you have to be careful of is that the closing rarely goes to plan and there are delays of up to a few weeks, which can cause the plan to unravel. Make sure any contract allows for this and you should be covered.
Contract for deed is an agreement whereby the buyer makes installment payments on an arrangement similar to car financing. That is, the seller holds the title to the property while the buyer has the equitable title.
Lease options consist of two elements, the first of which is the lease. This is a contract for use and possession of the property, thus creating a lessor/lessee relationship.
The second element provides a purchase option, which is a unilateral agreement where the seller agrees to give the buyer the exclusive right to the leased property. This is NOT a sale.
Make the effort to prepare your own income and expenses pro formas from the beginning, or get your accountant to do it. Don’t rely on operating results or projections presented by the agent or the seller – chances are the seller will overstate income and understate expenses, then claim ignorance if challenged.
The only way to know the investment value of what the property is worth to you, is to develop an accurate projection of income and expenses, which can only be obtained by researching the market and determining in advance what the cash flow will be once your investment and management plan is in place.
Also, you need at least a 20-25 % down payment to get access to the best financing terms. You can still get finance on a payment down to 10% but you will pay more interest, loan fees and private mortgage insurance.
Remember, borrowing to cover the majority of your acquisition costs can boost your rates of return, but too much debt expense can be dangerous if the market takes a downturn.