Buying and owning commercial real estate can be an exciting business venture. But like many investments, investing in property comes with risks and rewards. Before adding real estate to your existing portfolio, it’s important to understand the various factors that can lead to your success. Included below are a few tips to help guide you:
Know What Asset Class You Want to Play In
There are a variety of asset types in commercial real estate and most can be classified into four main sectors: industrial, retail, office or multifamily. Each sector is different in its own way and its crucial that you do your due diligence to learn which asset type will generate the most return in the area you’re looking to invest in.
Prior to investing in a property, it’s important to consider how involved you want to be in managing and maintaining it. If you want to take on an active role you may want to consider a nearby property that requires a hands-on approach such as multi-tenant office. If you’d rather have the tenant take on everything while you receive passive income, a triple-net lease (NNN) investment may be a better option such as drive-thru fast food or coffee businesses.
In addition, you’ll want to determine your lease terms. Do you want a long-term lease of ten plus years or do you prefer to play the market with shorter term tenants? Shorter term tenants may give you the opportunity to raise the rent above 2-3% annual increases. These topics and more are all things your buyer representative can guide you through.
Understand Your Risk Tolerance
What’s your risk tolerance? Answering this question will help you decide which property type is right for you. Looking at a property’s cap rate is one way to measure risk. A cap rate represents the annual return on your investment and is the relationship between the net income and the purchase price. In most cases, the lower the cap rate, the lower the risk and the higher the cap rate, the higher the risk and reward. It goes without saying that different asset types have different cap rates and different amounts of risk.
Let’s take a look at an example to help you better understand this concept. Say you’re considering buying industrial buildings. If there is very little available industrial space and there are many warehouse users looking to lease space, the cap rate will be lower – as will the risk.
It’s also important to note that the risk and cap rate of an investment can be affected by the property’s location, current lease term, tenant’s credit, age and condition of the property as well as the supply and demand of similar properties.
Don’t Expect to Get a “Deal” Because of COVID
Since COVID-19 was declared a pandemic in early March, financial markets have declined sharply, and the commercial real estate industry immediately looked ominous, especially for retailers. As people limited social contact, modern offices and experiential assets that combine leisure and shopping activities sat vacant for months, some closing permanently. In Arizona, due to our low vacancy rates in all commercial sectors, our inventory remains low. This means, very few if any deals will find their way to buyers at this time. It is possible that buyers and investors will see a different picture in 12 to 18 months when leases start to expire.
Whether this turbulence proves to be short-lived or not, it is difficult to say when many assets will return to their highest value. If you do find a “good deal” where you can take advantage at an asset’s discounted price, be sure to consider the future course of the property before closing the deal. Here are three questions to ask yourself before purchasing:
- Did the tenant ask for rent relief during the lockdown or shortly thereafter?
- Does the business’ current financial profile support the lease rate?
- Can you re-let the property if it becomes vacant?
- If not leased, can the building be sold at the value it was purchased or higher to an owner/user?
Make Money by Financing – Discover the Value of Leveraging an Investment
The ability to leverage a commercial real estate investment can be an attractive option for any investor. The premise: use less money, get just as much real estate. During this time, those with strong credit can finance with interest rates that are between 3.25% and 3.5% percent which is below many cap rate values. This is a rare time where investors could make money by financing.
Hire a professional to assist you through the transaction
Experienced representatives are crucial in winning a fair shake throughout purchase contract negotiations, reviewing the due period and getting the property to close. Best of all, they cost you nothing, nada, zippo.
A buyer rep will not only help you find the best properties, they’ll also help you negotiate the best deal and save you a lot of time, money and headaches. You can learn more about finding the right buyer representative in my past blog here.
1031 Exchange May Put You at A Disadvantage When Negotiating Your Investment
NNN investments that have tenants with essential businesses are in high demand for investors. Sellers are holding strong on their asking rates and many NNN assets are under contract within a week of going on the market for close to the asking rate. Many sellers are going with a sure thing – CASH. Tune in next month to find out some negotiation tips to win the property bid when you need to place funds for your 1031.
About Andrea Davis
Andrea Davis, CCIM, has practiced commercial real estate for over twenty years. Davis’s breadth of knowledge stretches from developers to landlords to buyer/tenant representation and investments. Within the commercial real estate industry, Davis has won numerous awards. The Phoenix Business Journal regularly ranks Andrea Davis CRE in the top 10 of Ranking Arizona for the category of Office Brokerage. Her book, SimpLEASEity™, focuses on leasing and is the first in a series of commercial real estate guidebooks. Her next book, Simply Own It, the American Dream, is forthcoming this year.