Investing In Commercial Properties 101

by Than Merrill | @ThanMerrill
Published on Wed, Feb 17 2016

It is always difficult stepping out of your comfort zone. If you have invested solely in single family properties, taking the plunge to multifamily or commercial can be a frightening experience.  Like anything else you do, once you accomplish something the first time, every other time gets a little easier.  This is the case with commercial investing.  While it may seem intimidating from the outside, it is just like any other type of investing you do.  It takes due diligence, proper management, and a full understanding of all the numbers.  Once you get past the psychological barrier of owning additional units, everything else is downhill.  If you are on the fence as to whether or not commercial investing is for you, here is some information to help you decide.

What Is A Commercial Property? A commercial property is any piece of real estate over four units. This can range from a five unit mixed used property to a large apartment complex of 100 units. It can be a 50 unit mobile home complex or a small strip mall. As long as you are over four units, you are considered a commercial property investor. What make commercial properties unique are the multiple income streams they provide. Instead of collecting rent from one tenant, you have several additional checks coming in. Making a jump from one tenant to ten sounds intimidating, but it is often much easier than perceived.

Economies Of Scale. One of the reasons that the additional units are not overwhelming is because of the idea of economies of scale. When you purchase a single family property, you have one roof, one front yard and one living room. With a five unit property you still only have one roof and one front yard. Some items such as a furnace and certain electrical items may be individual, but for the most part, you are getting more for your purchase dollar. In terms of management, you still only have one physical complex to worry about. There may be ten different tenants, but the physical property remains the same.

Vacancy Rates. The perception is that dealing with multiple tenants is a nightmare for rent collection. In reality, the opposite is the case. With a single family property, you have one tenant that is paying rent. If they don’t pay, you have no income coming in and the property is inefficient. With a commercial property, you have five or ten times more tenants that are paying rent. One vacancy does not totally derail your business. The more units you have act as protection against one bad tenant. Rent collection can be more difficult but it is worth it to protect against a vacancy.

Increased Financing Options. Another perception is that financing for a commercial property is extremely difficult. The reality is that you have more commercial financing options than you realize. For starters, there are a handful of no income or limited documentation lender financing options available. Lenders realize that most commercial borrowers do not want to pour through tax returns and bank statements. Even if you have the ability to document all your income, there are several commercial long programs out there. Aside from traditional lending, many private and hard money lenders are attracted to large commercial projects. It is easier to find financing for these types of deals than small single family homes.

High Upside. With a single or multifamily purchase you are at the mercy of comparable sales in the area. With a commercial property, comparable sales are not as important. The property is evaluated on the income it produces. An apartment with no vacancies is more valuable than what the market may indicate. Because of this, there is greater appreciation potential. With the right commercial property you can realize a higher upside. There is some degree of risk but the rewards are often much greater.

Instant Equity/Increased Cash Flow. Regardless of the lender you use you will need anywhere from 25-30% down payment. In certain situations the down payment may even hit 35-40%. While this may sting when you purchase the rewards will be instant. From the first month you own a commercial property you have instant equity. With this equity you also have the ability to generate greater cash flow. Since your monthly obligations are reduced you will have more cash at the end of the month. This cash can be used to generate additional properties or make improvements on the building. Whatever you decide to do increased cash flow make commercial properties appealing.

Decreased Competition. In almost any market, as soon as a hot single family property hits the market, there is often a handful of offers in the first few hours. With a commercial property, the demand is not has high. There are only a few investors who have the means or the desire to purchase these kinds of properties. This puts you at an advantage against your competition. You can make offers knowing that you are not up against a handful of others. You can pick and choose properties that you see value in without racing against a bank imposed deadline. You can end up closing more deals on properties you really want.

Commercial properties can be a great addition to your real estate portfolio. They may not be for every investor but you should not blindly ignore them based on preconceived perceptions.