There are many different ways to invest in real estate. While you can’t be expected to master all of them, you should have a basic level of understanding of how each of them works. That said, one of the more intimidating areas of the business is commercial real estate. People tend to think that more units translate into more work and more hassle. Moving from a single-family residential property to a 15 unit apartment building will certainly have a different set of challenges, but it is far from impossible. Like any other exit strategy, you need to spend some time understanding exactly what you are getting into. Once you feel comfortable and are ready to move forward, you will find that commercial properties can completely change your portfolio. If you have been on the fence with commercial real estate, here is a quick guide to help you get started.
By definition, a commercial property is any property between five and twenty units. It can also be a combination of a mixed use property coupled with a storefront. Because of the wide range of units, there is no difference in guidelines between a five unit property and a fifteen unit apartment complex. As simple as it sounds; if you are going to own five units, why not own fifteen? Once you move past a single-family property, you own to scale; everything associated with the property is under one roof. There is one yard, one roof, one building and parking lot. Managing these units is usually done by a full-time property manager that will charge the same fee, regardless of the number of units. The point is this; if you are going to make the move to commercial and mixed use properties, you might as well dive in with both feet and go for as many units as you can afford.
I encourage you to think long-term with any commercial redevelopment plans. For starters, the purchase process will take several months. Even if you have access to capital and can offer cash, performing due diligence is a lengthy process. To maximize your returns, you need to hold onto the property for a significant period of time. Your break even point may not be for several years. If you decide to sell before that time, you may have trouble finding the right market to sell in. Commercial properties require a unique buyer; one that has capital and the right mentality. Before you decide to do anything with a commercial property, you need to accept that it will be a long-term hold. If you are not thinking about the long-term prospects, a commercial property may not be the best purchase for you.
Running the numbers for a single-family rehab or multifamily rental property is pretty straightforward. There are a few basic expenses and formulas that almost every transaction looks at. When you get to five plus units, you need to look at a different set of criteria. No longer are you buying based on the property value; you are buying based on the projected income you can generate. Like any other property, location is the most important feature with a commercial property. If your property is not in demand, you won’t find tenants and you will be stuck with vacancies. You need to stay on top of cap rates, vacancy factors and net operating income. Learning these formulas can be confusing and frustrating at times, but they hold the key to commercial investing success. Find a real estate agent who specializes in commercial properties. They can help guide you on all of the numbers and formulas you need to know.
Financing for a commercial property is completely different than financing for even a four-family property. For starters, you are limited as to the number of available lender options. Most lenders require a minimum of 25% down, with some as high as 30 percent. Commercial properties are considered a higher risk factor than a single-family, and have higher interest rates and increased guidelines. Every unit is scrutinized and evaluated as part of the approval process. The down payment money must be seasoned for a longer period of time, and typically credit scores need to be much higher. If you have any interest in buying commercial properties, you need to set up financing as quickly as possible.
A commercial real estate purchase has a different set of costs than a single-family property. There is increased due diligence that needs to be done, even before you are ready to make an offer. Where a normal title search may cost you $500, a commercial property will be three times that. All of the costs associated will be much higher than you expect. It is not uncommon for a ten unit appraisal to be as much as $2,000. The same is the case with the inspection and other fees. These costs vary from lender to lender, but as a rule of thumb you will need much more money upfront with a commercial purchase.
Commercial and mixed use buildings offer something completely different for your portfolio. There is definitely a different set of rules, guidelines and information. However, once you master them, a commercial building will change how you look at real estate investing.