If you’re planning to invest in commercial real estate, you’ll want to put in some serious thought ahead of time.
While any type of real estate might sound like a great investment, the reality is that you could end up making an expensive mistake if you don’t know what you’re getting into.
Whether you’re buying a commercial property purely to rent out or whether you plan to use it for your own company, here’s everything you need to know.
So What is Commercial Property?
Commercial property is any building that’s used for business purposes whereas residential property is generally used as housing. You might immediately think of commercial property as office buildings, but it also includes malls, grocery stores, factories, warehouses, and much more. Commercial property is generally rented out by businesses, to businesses.
Broadly speaking, commercial property can be divided into:
- Office spaces (which can be broken down into different categories – we’ll come onto these in a moment)
- Industrial (places used to manufacture goods, such as factories, and places used to store and distribute them, such as warehouses)
- Retail (selling products and services, through stores, malls, and so on)
- Hospitality (restaurants, hotels, and beauty salons)
- Multifamily properties (apartment buildings with five or more units)
- Mixed-use buildings (such as a retail unit along with offices and/or apartments)
5 Factors You Must Consider
1. The Building Classification
Office buildings are typically classified as:
- Class A: high-end spaces that have been recently updated. These are often the most expensive, but they’re also usually in the most desirable locations.
- Class B: buildings that you’ll likely want to renovate after purchase, which generally cost less than Class A buildings.
- Class C: much older buildings (usually over 20 years old) that need urgent maintenance and repairs. These cost the least, but they usually require the most work.
Tip: These classifications are relative and depend on context. So, a Class A building in the heart of a big, thriving city isn’t necessarily directly comparable to a Class A building in a small, struggling town.
2. What is Your Long-Term Plan?
If you’re going to invest in commercial property, you should aim to create a long term plan. In most cases, you’ll either be investing a large sum of money in the property itself – or you’ll need to spend a lot on repairs and renovations.
You’ll want to take into account:
- Your business’s current and projected cash flow.
- How quickly you’ll be able to generate an income from the property.
- What problems might arise – and how you’ll handle them.
- Whether you plan to keep the commercial property indefinitely – or whether you’re intending to carry out repairs quickly and “flip” the property.
- How much you will want to spend on the property (even if it’s in good condition) – e.g. to make it more eco-friendly.
Tip: Determine how the commercial property will fit into your business as a whole. For instance, are you going to use part (or all) of the property for the company yourself? This will obviously reduce your rental income – but will also likely reduce your costs as you won’t need to rent office space.
3. Is it the Right Time to Buy?
You don’t want to buy a property just as prices are about to drop – so it’s important to consider market conditions. Is the commercial real estate market strong in your area or are you likely to come under pressure from a lot of competitors?
You also want to consider if it’s a good time to buy on the from a personal perspective. There are a lot of steps involved in a real estate transaction – so make sure you have the time and energy to dedicate to them.
Avoid rushing into buying commercial property – even if you’re convinced you’ve found a great deal. You need to take your time and be sure that this is the right point for you to buy.
Tip: Get impartial expert advice if you’re unsure. Don’t base your decision on things you’ve heard from amateurs – or from someone who has a reason to encourage you to buy (e.g. a commercial real estate agent).
4. Condition of the Building?
You wouldn’t want to expend a large amount of funds on a block of offices – only to realize that you can’t rent them out until you’ve spent hundreds of thousands of dollars more on essential work.
While it can sometimes work out well to buy an old building at a favorable price then pay for renovations, this can be a risky strategy if you’re not well-versed in buying commercial real estate.
Make sure you get the building thoroughly inspected so you’re aware at the onset regarding any potential problems. You should not solely rely on the seller to disclose these, even if they may be otherwise required to.
Tip: Inspect the building yourself, especially if you plan to use it for your own business purposes. You might determine that even purely cosmetic issues may warrant remedial work.
5. What Are Your Financing Options?
Commercial real estate is likely to require a significant amount of capital upfront. If your business doesn’t have that much cash readily available, which may often be the case, then you need to look into your financing options.
For instance, you might well be eligible for an SBA 7(a) Commercial Real Estate Loan, which lets you borrow from $500,000 to $5 million – which is generally more than bank term loans. Note that this type of Commercial Real Estate Loan can only be used for the purchase or refinance of commercial real estate that is 51% owner-occupied, so it isn’t suitable if you plan to rent out the entire property.
Tip: You might have more options open to you, when it comes to financing, than you might imagine. You should try to research all the different possibilities available to you before making a decision.
Commercial property is a huge investment – but one that could prove extremely profitable to your company. By considering the key factors above, you’ll be better versed when deciding on investing in your first commercial real estate building.
About the Author
With a background working for major financial institutions, Rupert is now an advocate of the financial independence movement. A passionate speaker, Rupert believes in helping individuals and businesses achieve financial freedom and is determined to bring his insights to the World.