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Commercial Real Estate Business Guide: What To Know Before Purchasing Commercial Property

Buying commercial real estate has the potential to be a highly profitable investment. Purchasing it, as opposed to simply renting or leasing, can be a great boon to the company owner who understands the real estate market and its trends, to the individual or company looking to build equity, and to those seeking a way to increase rental income.

Benefits

The benefits of owning your own property may seem pretty straight forward, but others might not be.

More Income

One of the other main attractions to purchasing commercial real estate is the ability to rent space. Strip mall and mini-mall owners as well as apartment complex and duplex owners are the prime examples here. Each of these owners either builds a structure and rents out empty spaces within it or has rented the land to business owners looking to build. Either way, these commercial real estate owners are making money from otherwise empty space. These businesses or individuals being leased to are also aiding the owners in increasing their equity.

You are Building Equity

Equity is the value of the owner’s share of a given property. When you initially finance a property the amount of equity you possess is very little. With each dollar returned to the bank, you increase your equity. The more you pay, the more the value of your investment grows. If, and hopefully when, the property appreciates, the value of each dollar paid to the bank increases, and your property gains additional value.

Getting Appraised

A proper appraisal of the property should always be sought prior to buying and can save a lot of time, money, and headaches later on. There are three main ways to appraise commercial real estate. These include the cost approach, the sales comparison approach, and the income capitalization approach. Knowing which method to use is key to getting the most value from a given property, as each has its own advantages and disadvantages. The cost approach assumes that the value of the property is equal to the cost to construct or replace the property. It requires an intricate knowledge of material costs and construction and is not commonly used.

The sales comparison approach is most often required if an investor is looking for conventional means of financing. This method requires the selection of properties with similar characteristics that have recently been sold in the same market. A professional appraiser will compare all the properties. Where the primary property is found to be deficient, the value is decreased, and where it is found to be superior, the value is increased.

The income capitalization approach determines the value of the property based solely on its income in comparison to similar properties. Sales values are produced when an investor with knowledge of current capitalization rates in the appropriate market divides the income generated by the property by the capitalization rate.

Pitfalls

Though commercial real estate is a great investment and can provide serious income, buying commercial property can be risky if the buyer does not understand the real estate market and its trends.

Future Growth Potential

A common pitfall that many business owners make is choosing a less-than-ideal location for their business in terms of growth possibility. Although the location may look good at the present moment, consider whether it will be beneficial in the long run. Could your business lose its commercial appeal, all but ruining any return on investment?

Poor Planning

Due to the relatively slow rate at which commercial real estate appreciates, proper planning is a must if you hope to be successful. Prior to financing you must be sure of what you can afford and the amount of risk that you are willing to accept. In other words, can the rental rates or income of your property support its expenses, such as taxes, insurance premiums, repair, maintenance, and loan payments?

Each market is, for all intents and purposes, unique, though averages over a large area can be attained. Put aside your desire to be completely in charge of your business and how great it would look on that new plot of land and focus instead on the area around the property. Walk around. Observe all the surroundings. Look into the rent and pricing of other similar commercial real estate properties in the area. Are that particular property and the surrounding area good for your business? Can you compete with the other businesses in the area? Are there other businesses that could compete with you?

Financial consultation is also an important part of the planning process. This will allow you to structure your purchase so that it meets your goals. Meet with an accountant to discuss the most ideal way to move forward financially.

The High Cost of Ownership

Investing in commercial real estate is a costly endeavor and should not be considered lightly. With down payments of up to 25% of the final cost of the purchase, a mortgage, moving costs, and more, a commercial real estate purchase is a decision that should be made only after careful consideration of your business’ current and potential income and its ability to prosper at its current and potential properties.

Pricing

The bottom line with a business and its finances is money. Every investment requires risk, but knowing how much you are willing to risk and the potential value of not only your business but also of the property it is located on are key factors when considering the step up to property owner and operator.

Cash Up Front

Purchasing commercial property can involve a down payment of as much as 20 to 25% of the final price. It is almost always required before any financing transaction can be finalized. If your business finds that making this kind of payment is not financially feasible, then it is probably not the time to purchase real estate.

The Mortgage

Following the down payment, monthly mortgage payments begin. Mortgage payments are usually calculated as 28% or less of the total income of the borrower. Prior to purchasing real estate you should calculate the financial capability of your business. This way you will know before any papers have been signed, or time has been wasted, if you can handle the mortgage on a monthly basis.

Other Costs

Business owners on the way to a new and exciting location often overlook moving costs. You want to retain any previous customers or occupants that your business had while at its former location, so advertising is necessary. This can lead to a lot of additional expenditure that may not have been calculated previously.

Be sure to weigh the benefits of owning commercial real estate with all of the responsibilities and potential problems that could come with it. Understanding your market at both the micro and macro levels and its trends should always be one of your top priorities before looking to purchase. Keep in mind that the most important thing to consider before a move is whether or not your business will prosper there.