7 Fundamentals of Commercial Property Investing for Beginners
- By Acquisition Consultants
- June 4, 2020
For those who are looking to start investing in commercial real estate properties, basic foundational knowledge is necessary to know where to begin and how to manage such lucrative investments. The following information will serve as a guide for beginners, providing them with a clear breakdown of the essential strategies used by professionals, as well as other investment related terminology and tips.
Potential investors must prepare a plan before investing in any form of property to ensure that the purchase has a beneficial impact that aligns with the objectives of each investor. The following three investment categories should be read over and considered before any major financial decisions are made.
All of the following questions should be answered before investing in commercial properties:
• Analyze the quality of the tenants in the property and in the area. Can these tenants survive a recession? Are the lease terms long or soon to expire?
• How much will the property yield financially on a monthly basis? How does this yield compare to the other alternative investments?
• What is the physical and financial state of the property being purchased? How much work is needed in order for the property to reach its fullest financial potential?
• What is the time frame between when the investment will be made and when the spaces will be available for renting out and leased up, i.e.: how much time is consumed by the lease up period?
• What is the condition of the local market economy in the immediate area? How many people live in the area? How many people are expected to leave or move to the area? Is there room for economic expansion in the surrounding area? Is there pent up demand for this type of commercial space in this specific market?
Multi-family investment properties are buildings meant to provide residential spaces for more than one tenant. There are two major projects that can be purchased within this type of investing.
• The first type of apartment project investment is based on current financial performance. These projects are often large with many apartment units offered. They typically have a proven track record of occupancy and lease rates. Normally, these assets are well maintained and allow for low operating costs due to economies of scale.
• The second general multi-family investment type is in properties that need significant work to be financially sound. This can include physical renovations or financial work due to poor occupancy. Many times these are older complexes which have not been renovated for some time. Due to their more outdated nature, fewer people are willing to rent these apartments, and the amount of money they are spending on rent will likely be lower. The cost of maintenance is expected to be higher for these types of projects.
It is important to consider the duration between making the initial investments and when the property will finally perform well financially.
For those who are searching for a lower risk. triple net leased assets are a fitting option. This strategy essentially requires the renters to pay for maintaining the property. As a result of this strategy, less involvement is required on behalf of the investor. For this reason, however the financial yields will not be as high as other forms of commercial property investments. Though the financial yields may not match those of other investments, this strategy is much safer and requires less involvement. Net Leased properties (in contrast to Triple Net Leased) are those in which the monthly maintenance and management costs are paid by the renters, while the owners are responsible for paying costs related to parking, and maintenance of the structure and roof of the property. For shorter leases, investors will achieve a higher CAP rate (return). For longer leases, a lower CAP rate is applicable due to the lower risk. Be sure to critically research and learn about the tenant to avoid major issues.
The following fundamentals are related to various types of information and investment jargon that are essential for beginners to know and understand.
The following information will provide those interested in investing with a basic understanding of how commercial property financing works.
• Firstly, investors need to understand how interest rates work when obtaining commercial bank loans. They are unlike a residential loan.
• Investors also need to understand the process of amortization, which is the period of time that payments are being made to banks in order to fully pay off the loan. Often, this period of time will be connected to how long the lease contract lasts.
• Triple net leased assets typically require 25% to 35% of the money to be paid up front as equity. Routinely, the interest rate is lower than multi-tenant shorter leased assets due to the lower risk.
• When it comes to multi-family financing, the two major types of lending include traditional and agency lending.
• Interest rates may be fixed, adjust after a specified period of time, or even float monthly.
For investors, it is crucial to understand how to properly analyze finances. Also known as a proforma, a financial analysis document includes lease income and operational costs and other property related details. The following includes some of the information that is included in proforma documents.
• The earning potential of the property based on it possibly being fully rented out
• How much it costs to manage and maintain the property
• The current vacancy rate
• Cash on Cash Return
• Information related to debts being paid
• Net Operating Income: Income that is received after all costs are paid including taxes
• Internal Rate of Return: A report of the performance of an investment
The amount of compensation a property manager will receive for their position depends entirely on how much involvement they have in maintaining the daily operations of properties. Highly involved property managers will receive higher pay than those who are not as involved. By way of example, triple net leased assets require very little management work. On these assets the property manager may only charge 1% of the gross revenues for the month. Conversely, if the property has 72 tiny 200 square foot tenants, the management fee may be as high as 10%.
Deciding which types of properties to invest in can be a difficult process to undertake, especially for beginners who are just getting into the field. Luckily, those looking to invest can receive assistance from professionals and experts who are knowledgeable and have experience working in real estate and with investments, in particular.
At Acquisition Consultants, our team of professionals has dedicated themselves to providing a valuable service to investors for over 25 years. Potential and current investors will receive expert level assistance on which assets to buy, guidance related to managing their commercial properties, and how to maintain their financial viability. For more information about commercial real estate investments and how to increase their profitability, contact us at 407-373-0930 or visit our contact us.