Investing in Commercial Real Estate? Avoid These 7 Mistakes
We all learn from our mistakes. But if you can learn the lesson without having to make the mistake, then that is certainly preferable. Here are seven mistakes people sometimes make when investing in commercial real estate. Read about them now, so you can avoid them later.
Whether you are a seasoned investor or a beginner, you’re better off teaming up with an experienced broker, real estate attorney and other professionals that know the market and the process of buying property. A broker will work to understand your goals in order to find properties that match your needs. Furthermore, purchase contracts are complex legal documents. Both your broker and attorney will explain the fine print and ensure that you pay a fair market price.
Letting Your Emotions Take Over
As the saying goes, “It’s not personal, it’s business.” Commercial and residential real estate are different in many ways. When you’re looking for a home, there really might be a house that you love. It is personal, because you and your family will live there. With commercial property, however, never let emotions factor into your decision no matter what the property looks like or how prestigious the address. Instead, base your decision strictly on sound business considerations.
Misunderstanding the Market
First time buyers especially are at risk for buying the wrong property at the wrong time. They may want to get into the market in order to diversify their investment portfolio. And while it’s true that real estate does tend to go up over time, this doesn’t mean that you should rush into a decision even when the market is doing well. You need to be sure a property is a good investment decision for you. That requires thoroughly understanding the market and sub-market so you don’t overpay, which will lower your return over the long run.
If you are a business owner, then understanding the market also entails knowing the demographics of the area. Data analysis is critical in order to know whether or not the market will support the product or service your company offers. You’ll need to look at population and job growth, the unemployment rate and property taxes among other stats. Failure to do this while you are looking at different locations could ultimately hurt business.
Neglecting Operating Expenses
Sale price isn’t the only number you need to be concerned about when considering a commercial real estate investment. No matter what kind of building—office, retail or industrial—you must calculate the operating expenses. After the sale is no time to find out how much money it takes to run the building. Ask the current owners to provide a report of average monthly operating costs.
In many cases also, you are paying a much higher price than what the appraisal district has valued the property. Therefore, be prepared for an immediate increase in taxes once the appraisal district recognizes the new purchase price.
Overlooking Tenants’ Leases and Earnings
When investing in a building that has tenants in place, carefully evaluate their existing leases. If most have signed short-term leases, then you may find yourself with vacancies to fill in a few months or years. This, of course, will reduce your income. Also, be aware if any of the tenants have special provisions such as co-tenancy, which means they have the right to a reduced rent or a lease cancellation if a major tenant within the center vacates.
Are any of the tenants retailers? If so, then you should inquire about sales. The rent-to-sales ratio will be an important indicator of whether or not the business has longevity. In most markets, rent should not be more than about five percent of sales.
Focusing on the Present
Will your company occupy the investment property? In that case, you not only need to meet your immediate needs, but you must also consider the future. You want the property you choose to accommodate growth, reorganization or even downsizing.
Failing to Plan an Exit Strategy
Whether things go well with your commercial real estate investment or not, having an exit strategy is always a good idea. Let’s say the property appreciates, and you’re ready to sell. You need to have a plan for what will happen to the funds. This way, you don’t end up paying a lot of taxes. A 1031 exchange allows you to defer the tax if you purchase a replacement property of equal or greater value within a certain time frame following the sale.On the other hand, if your investment does not work out, then an exit strategy can be an important safety net.