13 Golden rules of investing in commercial real estate

In simple words, Commercial real estate is a property where people do business.

Annual returns in CRE range from 6% to 12%, compared to 1% to 4% for residential properties.

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• Important considerations & risks in commercial construction and retail development 
  

The drawbacks of commercial real estate

Commercial property is not for everyone, and no investment is risk-free. The following are some potential drawbacks in this industry:

Insufficient liquidity

Property trust shares are widely available for purchase and sale. It is not the case with most other commercial real estate transactions.

Property syndicates are usually for at least five years, and to sell a holding is difficult unless you can locate a buyer yourself.

One can sell a direct property investment, but it will take several months and incur the usual selling charges, much like a home. It could be a problem if there is a severe economic crisis, and you need to sell a specific commercial property.

When it comes to stocks, you may sell at a loss. However, in the case of commercial property, it may entail months of work or even no purchasers at all.

Lack of pricing information

Your newspaper publishes stock prices every day. Prices for managed funds are also readily available. You will often find each suburb's average property prices in the newspapers' real estate sections. 

However, aside from sales announced in the daily newspapers, there is little cost information available for commercial real estate developers.

So, unless you own a property trust, you have no data of a particular property in the market and the increase in its value.

For this reason, the Property Council of Australia created its commercial property investment performance index, which measures income, capital gain, sale, and total return. Based on billions worth of property, it has become a benchmark for several investors.

Other information is scarce

Take an interest in the stock markets; you will find an abundance of investor information—far more than you can consume. Magazines, books, newspaper supplements, seminars, training courses, websites, stockbroking newsletters and reports, and so on are only a few examples. 

Even the residential real estate sector is well-covered, with books, at least one magazine, and regular media appearances.

However, except for a few articles and breaking reports on listed property trusts, there is little guidance for commercial property investors. Several real estate agencies strive to educate potential investors with books and websites. 

The fact is that, as a newcomer to the commercial property market, you will have a difficult time finding enough published data to help you distinguish between a good and wrong investment property.

High-price

If you merely have a few thousand dollars to invest in commercial property, listed property trusts are likely to be your best option. Property syndicates generally require a minimum investment amount, usually at least $10,000. 

You won't be able to get into direct property investment with less than $100,000, and you'll almost certainly need much more. In contrast, you can start little (about $500) with the stock market and progressively increase your investment.

Ongoing supervision

Direct property investment may necessitate your continued participation in the property. You'll have to maintain the property yourself unless you hire professional commercial property management.

Market trends must be kept in mind. For example, if you own an office building, the owners of adjoining workplaces may be rewiring their buildings with high-speed telecommunications cabling. If the tenant leaves, your property may become less appealing until you follow the same.

Furthermore, even while lease arrangements provide significant security, they cannot prevent a tenant from falling insolvent. That's when the tenant's bank guarantee (or bond) comes in handy.

Overall, if you're just getting started in commercial real estate, it can appear to be pretty tricky. And many of the market's professionals are content for it to remain a secret to all except the most privileged few.

As a result, this article aims to assist in 'lifting the veil' on these commercial real estate insider secrets. Enroll on one of my structured property development courses and achieve ultimate success in property development.

You might have heard this before - the higher the risk, the better the reward. Similar to this, we can't deny that the lower the cap rate, the lesser the risk.

Liabilities are just assets in hiding.

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The Safe Way Is The Only Way!

You can make a million excuses, or you can make a million dollars.

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• Have you included these property development costs in your budget?

How to buy your first commercial property?

The process of buying a commercial property can be complex, so it's essential to do your homework and work with a qualified real estate agent or broker. Here are the basic steps you'll need to follow:

Define your investment objectives

What are you hoping to achieve by buying commercial properties? It will help you focus your search and narrow down the options - the later section of this blog details 8 primary property investment objectives and ways to achieve them.

Answering the following questions will help you understand what type of commercial real estate to buy and where and how?

As an individual investor, you must determine what your primary objectives are. 

You may want to accomplish all four of them, though one or two of them will likely be more significant than the others. Make sure that property is the best way to increase your wealth.

Two of your primary concerns will be to 

1. safeguard your first investment.
2. reap a valuable, long-term benefit from it.

If these are your primary concerns, the investment options available to you are likely to be limited. That is why making a plan and sticking to it is so important.

Research the market

Get familiar with current market conditions and prices for different Commercial real estate properties. It will give you a realistic idea of what you can afford. Check out this 13 Easy Steps Real Estate market analysis blog for researching the market. 

Hire a real estate agent

A good agent will have extensive knowledge of the local market and can help guide you through the buying process.

Submit an offer

When you find a commercial real estate property you're interested in, submit a written offer to the seller.

Negotiate the terms

Once the offer is accepted, you'll need to negotiate the final sale price and other transaction terms. You can seal a great deal with these 7 real estate negotiation tactics. 

Close the deal

Once all of the negotiations are complete, you'll need to finalize the purchase by closing the deal.

Dos And Don'ts Of Commercial Properties Investing

Here are some "dos and don'ts" that have survived the test of time:

1. Keep enough cash on hand to cover several months' worth of mortgage payments if you lose a tenant or if the tenant is late in paying. Having enough cash to satisfy any due or unplanned obligations cures investment sleeplessness faster than anything else. Keep an eye on more minor expenses as well, such as equipment and maintenance bills, as they may quickly mount up.
2. Make an investing plan that you are comfortable with and stick to it—set attainable goals and work toward them. More goals have gone unachieved due to a lack of planning than a plan's failure.
3. Invest in a solid financial calculator or software application like the feasibility suite and learn how to use it correctly.
4. Continue your quest for education by following real estate news and laws, attending seminars, and keeping up with current trends. Knowledge can help you reduce your risks while increasing your income.
5. Hire a top property consultant and a capable property lawyer, and hire means to pay for their services. To get back what you pay them, they should get you better deals than they charge you.
6. If feasible, avoid personal liability on mortgages by making the property your sole security.
7. Only put a modest portion of your money into speculative ventures. On the way in, they may appear dazzling, but on the way out, they are frequently painful.
8. Never make a contract based on a handshake; instead, put your agreements in writing.
9. Consult with your retained advisers before entering into joint ventures or partnerships.
10. Avoid mortgages where there is an influence of factors outside your control on the payments. Don't take out all of your mortgages at the same time. At the very least, have a 50/50 split of fixed-rate and variable-rate mortgages.
11. Don't invest in commercial real estate properties with significant negative cash flows (i.e., where your expenses far outnumber your income).
    

8 Primary objectives of commercial real estate investing

Now that you've worked through some 'big picture' difficulties to help you clarify your overall approach, it's time to create a list of particular goals and buying criteria. It will assist you in finding suitable commercial real estate properties within your price range.

There are eight goals for commercial real estate investing.

When developing your investment strategy, you may choose to change the particular order of significance for the following set of objectives. It's up to you to figure out how they'll fit into your overall plan. Furthermore, you are likely to have competing objectives, necessitating the development of strategies and procedures to determine how you will achieve each one. Let's look at some of the leading financial goals that have lasted the test of time. The property in question should:

1. Be valuable in the long run
2. Maintain a steady cash flow
3. Maintain a stable rate of growth
4. Encourage super-growth
5. Keep the loan appeal going
6. Come up with future collateral
7. Provide for expense control
8. Provide tax benefits.

#1 Value that lasts

If you're a long-term investor, you've probably already learned from my articles that a property's enduring value - remaining appealing even after many years and multiple tenants change.

It links with understanding current trends (both cyclical and emerging) how they will affect different property types and time frames. As a result, the enduring value should be at the top of your priority list.

#2 Continual cash flow

An investment in a prime location that does not guarantee steady income will not assist you in meeting your monthly mortgage payments. As a result, anytime you plan commercial real estate investing, you should always look beyond the first few years.

That is why it is critical to developing a marketing plan from the start. When it comes to selling or re-leasing the property, you should be able to choose from a variety of possibilities.

#3 Consistent growth

Although inflation has been under control in recent years, you should ensure that each investment provides you with consistent and predictable capital growth. The type of property will depend on the location and the anticipated market for that property at the time.

#4 Exceptional expansion

With a good consultant, you'll occasionally find investments that offer real growth potential above and beyond the market average. It can happen as a result of a clever change of use. Componentisation can result in subdivided properties.

Always be on the lookout for hidden jewels that might help you boost the total worth of your portfolio. Furthermore, as you gain a deeper understanding of the influence of your buying criteria, you'll be able to zero in on exactly which properties might provide you with this type of rapid development.

#5 Appeal for a loan

To keep your lender happy, make sure you have a steady cash flow, long leases, minor maintenance requirements, and a desirable location. It would help if you began to consider each of your potential investments from a lender's perspective. That way, you may be confident that practically every financial pitch you make will be successful.

#6 Collateral in the future

It is critical to be able to borrow money right away. To reassure your financiers and underpin your future borrowing capacity, you must also look a little further ahead to when should you consider a piece of your core portfolio as being retained for the long term.

#7 Cost-cutting

Even if your rent money is secure, you should look for properties with net leases wherever possible (where your tenant pays all the building outgoings). What is the significance of this? Because without careful management, your property's operational costs (such as rates, taxes, maintenance, and service contracts) may unexpectedly arise, affecting your overall return.

As a result, you must defend yourself on two fronts. Controlling costs is equally as effective as raising rentals to improve your bottom line.

#8 Tax advantages

You should view tax benefits as a subsidiary rather than the primary purchase motivation. There's no denying that depreciation allowances can provide significant benefits (as well as income protection). 

However, if the bargain isn't viable before considering prospective tax savings, you shouldn't be acquiring it in the first place.

Key considerations when buying commercial property?

Let's take a closer look at the specific things you'll need to consider when buying commercial property. Below are 10 significant criteria for investing in commercial property.

You'll need to create specific purchase criteria to meet the investing goals discussed above. You can use these to evaluate every property investment you make. These criteria depend on their relative relevance for making sound property investments, as most investors determine over time.

#1 Tenant calibre and lease duration

The tenants' calibre and the lease length could be the most critical factors in attaining your financial goals. You're well on your way to making a successful commercial property investment if you have solid corporate (or government) multiple tenants and a minimum five-year lease term.

#2 New Construction

In general, when a commercial real estate is newly constructed, it will continue to appeal to future tenants and will require less maintenance to preserve its current aspect. 

Because of this, you can achieve many of your goals, including enormous tax advantages due to generous depreciation allowances during a building's early life.

#3 Flexible design

A flexible design also means you won't be left with an inefficient floor plan if your primary tenants leave at the end of the lease period. When it comes to re-letting, you'll have an easily flexible plan that allows you to tap into a large market, along with an excellent rental income.

At that point, you can take advantage of further savings available on property taxes by depreciating any necessary renovations.

#4 The lease structure

The frequency and method of your rent reviews, who pays the operational costs, and the extent to which a tenant is liable for total building maintenance are all factors to consider when negotiating a lease. You can negotiate these elements deal-by-deal, but they affect many of your goals.

#5 The lack of competition

In the past, many commercial landlords were local investors. These days, large, national corporations have started to buy up these properties as they offer both stability and economies of scale.

The lack of competition can be a good thing for new investors, as it gives you the opportunity to get in on the ground floor and grow with the property. It also means that you're more likely to get a fair price when you're buying a property.

However, it's important to remember that the lack of competition can also lead to higher prices for properties and fewer negotiating power when it comes to leases. So while it's good to be aware of the lack of competition, don't let it dissuade you from investing in commercial real estate.

#6 Emerging trends and a strong position

If all other factors are equal, the better the location, the better the performance of your commercial real estate property. What defines a good location depends on various criteria, some of which are subjective. 

The nature of the property, including factors such as visibility, public transportation accessibility, and location within a defined area, determines it for that sort of commercial property. However, as with the other criteria, you should not use this as your sole criterion.

What is the meaning of emerging trends? Demographic dynamics, such as population shifts, always lead to new investment opportunities.

New trends in building, design, energy conservation, security, elevator technology, automation, and so on are also emerging. All of these will affect the future demand for and appeal of the sites.

Taking advantage of a new trend as soon as it emerges can significantly boost the performance of any sites you already own, as well as provide you with the ability to improve underperforming properties you're looking to buy or build.

Keep looking for hidden opportunities to obtain a competitive advantage.

#7 Yielding

Passing yield refers to the current yield on an existing investment. You are unlikely to receive any increases from your market reviews if you derive it from rentals regarded as 'above market' (that is, more than the rents already being paid by tenants of similar sites). 

Alternatively, suppose the rent is below market and with fixed future reviews, incremental, or tied to the Consumer Price Index. In that case, you'll be adding to (and deferring) the problem until the lease expires.

On the other hand, your passing yield may be at market rentals. It should imply that your cash flow will improve, and you may even see some exceptional growth if you spot an opportunity that many investors may have neglected.

#8 Zoning passes

Zoning refers to the current and potential uses of your commercial real estate. Your local government can provide you with zoning laws and other related information.

A 'non-conforming use permit' can sometimes be obtained, allowing residential property as an office space. While you can currently utilise it for workplaces, it may only be possible to use it for residential purposes in the future.

Suppose many of these non-conforming properties have existed in a specific neighbourhood in the past. In that case, some inner-city towns have introduced 'mixed use' zoning to legitimize (and actively encourage) the coexistence of uses. 

It's something you should be aware of because specific zoning and density changes occur regularly, and if you're lucky, you can profit from them.

#9 Title possibilities

A property surveyor can tell you (for a small fee) if you can subdivide the title into a parcel of land or an entire structure, in which case you can significantly increase the marketability and thus the value of your commercial property.

You can still sell the property as a whole. Still, new buyers may be drawn in by the added flexibility of selling off a section of it if the need arises - and people are willing to pay a premium for that flexibility, which is typically well above the cost of constructing it.

#10 Vendor motivation

Although vendor motive is essential, it should not be your primary reason for purchasing a commercial real estate property. A motivated provider will invariably give you some additional fascinating perks after you've analysed all of the fundamentals and satisfied your prior standards. 

These can range from leaving some money in the property at a low-interest rate on a second mortgage to allowing you to up value all of the plant and equipment so that you can depreciate it from a much higher base.

A seller may specify the written-down value of a property's plant and equipment (also known as chattels). However, the contract is frequently silent on the specific worth of these assets. 

It allows you to apportion the contract price by valuing the plant and equipment at their current-day worth, resulting in a more extensive depreciation base and an immense tax advantage. This process is known as 'up valuing.'

When working with a motivated vendor, your primary focus shifts away from price to establish the most favorable contract conditions.

Summary

So, if you are looking to invest in commercial property, make sure that you ask yourself the following questions to buy a property that meets your investment objectives. 

Have you determined your primary investment objective? What type of commercial real estate do you want to purchase (office space, retail plaza, industrial park etc.)? What is the length of the lease terms?

I've covered all of these questions and more in this article. But if you want to learn more or take your property investment and development skills to the next level, I suggest you enroll for my Property Development Courses. 

In some weeks, you will gain an in-depth understanding of the real estate market – from finding deals and negotiating leases to maximizing your return on investment. You can confidently achieve your property investment objectives with my course under your belt.

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