Most assignments we take on in the commercial real estate sector are for developers that hire us to communicate why others should invest in their proposed project. Many developers believe that building a project is the hard part and that investing is as easy as writing a check. We know from experience that this could not be further from the truth. Successful investing in commercial real estate developments or any other kind of commercial real estate requires discipline, attention to detail, an understanding of the risks and rewards, patience, and perhaps most importantly, knowing when to say “yes” and knowing when to say “no.”
Our goal with this article is to provide a step-by-step approach to successfully investing, owning, and exiting commercial real estate properties. And by the way, whether you intend to invest in a 2,400-square-foot fourplex in Cleveland or a 160-unit apartment building in Scottsdale, the investing principles are the same. Your step-by-step approach will include:
- Defining your investment objectives
- Executing your investment strategies
- Finding the perfect property
- Conducting your due diligence
- Arranging financing
- Closing the transaction
- Being a good owner and an excellent landlord
- Preparing to Exit
All investors have different investment objectives and real estate investors are no exception. Commercial real estate properties have been a vehicle that can respond to any investment objective. Below are some of the objectives that commercial real estate investors might have:
- Growth – Many investors buy commercial properties because they wish to grow their assets by investing in a building or buildings that they believe will increase in value for reasons that might relate to the general economy or because of strategies they may employ to cause that growth.
- Current income – Many investors are looking for stable income that will come from a property that has low vacancy rates and is professionally managed.
- Preservation of Capital – Many international investors find that investing in commercial real estate properties in stable economies such as the United States, Canada or Western Europe is an excellent way to preserve their capital from unwanted economic or currency fluctuations.
- Passive investment – Many investors invest in commercial real estate properties that are professionally managed because they are interested in a satisfactory return on investment but do not wish to be actively involved in the investment.
- ESG – ESG stands for environmental, social, and corporate governance, 3 central factors used in measuring the sustainability and societal impact of in investment in a company, business, or real estate property. Socially conscious investors may only invest in buildings that have a low- or zero-carbon imprint. As an example, perhaps the building generates its own electricity from solar panels on the roof of the parking garage.
Now that we have examined some commonly used investment goals, we need to discuss the strategies that successful investors use to achieve those goals. The term investment strategy refers to a set of principles designed to help an individual investor achieve their financial and investment goals. These principles are what guide an investor’s decisions based on goals, risk tolerance, and future needs for capital. Below are several frequently employed investment strategies:
- Value investing is often defined as buying a property that is intrinsically undervalued. For example, It can be acquired for less than its replacement cost.
- Turnaround investing usually involves the purchase of a “C” property in an “A” neighborhood or buying a property that has not been properly maintained and/or poorly managed such that the rents are below market and the vacancy factor is above market.
- Contrarian investing is for investors that see the benefits of an investment that other investors overlook. This leads to investments that are mispriced. Contrarian investing is often used in the context of the securities markets, but it is equally as valid in real estate. According to Friedman Toronto, a Canadian real estate broker, “the first and most important step in being a contrarian is to be comfortable being uncomfortable.”
- Repurposing is the act of buying a commercial real estate property that may be an underperforming rental building and reimagining it as a condominium or replacing all the apartments on the ground floor and renovating the space as retail.
- Developing commercial real estate properties for low-income tenants can be 100% funded using government incentives. In other words, be an investor in a property for which you have only invested your time and experience.
Finding the Perfect Property
There are many excellent sources of commercial real estate properties for sale in virtually every market and if you intend to build your own property, you will be able to use the same resources to find the parcel that will fit your investment parameters. Your first stop should be to research the large real estate brokers in your market. Here are some good places to get started:
- LoopNet.com https://www.loopnet.com/)
- CBRE (https://www.cbre.com/about/corporate-information)
- Marsh & Millichap (https://www.marcusmillichap.com/)
- JLL (https://www.us.jll.com/
Due diligence is arguably the most important aspect of real estate investing and perhaps, any type of investing. According to Roofstock, an online marketplace for real estate investors, “due diligence means investigating facts about the physical and financial condition of the property and the area the property is located in. A good way to think of due diligence is ‘doing your homework’ both before you make an offer and after your contract is accepted. As a rental property investor, due diligence helps you to verify that you are getting the property and cash flow that you’re paying for.”
Funding Your Acquisition
What percentage of commercial real estate in the United States and all other western countries are financed, at least in part, by debt? The answer is virtually all of them. Income-producing real estate is a favored type of collateral for any bank or lender because of the property’s collateral value and because of the property’s cash flow, a part of which is used to repay the loan. Commercial real estate loans typically have terms of 20-25 years and can usually be structured to precisely fit the investor’s investment objectives. Note that most commercial lenders will require a business plan to be submitted as part of the loan package. What are they looking for? Have a look at some sample real estate business plans here.
Closing the Transaction
Now that you have completed your due diligence and received a commitment from a lender to finance 75% to 85% of the purchase price, it is time to close your transaction. In most cases, your attorney will have played a role in the due diligence so he or she is most likely already working on the closing documents that will transfer the ownership of the property from the seller to the buyer. While you have played an important and active role in the investment so far, this is where the smart investor turns the process over to his or her real estate attorney.
The Responsibilities of Ownership
Your tenants, the renters of your property, have an obligation to pay their rent on a current basis. In return, you the owner/investor have an obligation to provide each of your renters with a clean, safe home or space that is always in good working condition. This is called “property management.” Investors in smaller properties will often manage a property themselves, while investors in larger properties will often hire a professional property manager to manage the property. In either case, it is your responsibility to see that the property is always managed with the interests of the renter in mind.
We truly hope that your investment in a commercial real estate property has enabled you to exceed your investment goals. Of course, the time will come when it is time to sell your property to another investor. There are many reasons why you might want to transition from being an investor to being a seller of your property. The “why” isn’t especially important. What is important is that you have planned for your exit and that you execute your exit as professionally as you have owned and managed the property. The decision to implement a sound exit strategy is crucial to success, as the correct approach will ensure maximized profits and minimal risks. Your strategies to exit the investment should include:
- Ensure that the property is well maintained; that all units are in good working condition; and that the property has excellent “curb appeal.”
- Renters have enjoyed being your tenants, resulting in limited turnover.
- Your rents are at or above market rates.
- All property records are in order.
- You’ve listed the property for sale with a reputable commercial real estate broker who will market the property professionally.
- Once you have received a fair offer, it is time to turn the closing of the transaction over to your attorney.
Robert Kiyosaki once wrote: “real estate investing, even on a very small scale, remains a tried and true means of building an individual’s cash flow and wealth.” If commercial real estate investing is new to you, we hope that this post will serve as your roadmap to successful investing. If you are an experienced investor, perhaps this post will serve as a reminder of what made you successful.
Credit: This post was co-authored by Jimmy Lewin and Scott Pollov.