There is a normal progression most buy and hold investors take. After getting started with a single family rental they move up to two, three and four unit properties. Eventually they become more comfortable with the additional units and look to take on bigger projects. The next step up from multiple units is commercial, apartment and mixed use properties. While this may sound intimidating managing the additional units is not that big of an adjustment if you have experience. With additional units comes additional responsibility but also increased income potential. Some of the wealthiest people in the county have made their wealth through commercial real estate. This certainly doesn’t happen overnight but the long term potential is there. If you are interested in getting started in commercial real estate here are four basic items you need to be aware of.
- Accept Differences. Taking on additional units is very much like running a busy family. With one child you think things are tough but you have time to figure things out. If you have a second child things get more spread out leaving you on constant patrol. If you are daring enough to have a third or fourth child you know that your time is limited but with experience you have a better sense of how to handle things. The same is the case if you have five or more children. The point is that anything new always seems difficult and daunting but you usually find a way to figure things out. The first step in commercial real estate is accepting that while the process is similar there are many distinct differences. Aside from the obvious difference in units there are many different formulas, calculations, expenses and jargon you need to be aware of. Soaking this all in may seem daunting but it gets easier the more you learn about it.
- Market. Buying real estate on any level is largely about supply and demand. This is just as important if you are exploring commercial real estate. You need to know that the market can support the property. With a single family property your rental pool is much larger than with a commercial property. You need to entice business owners and tenants who find the market appealing enough to commit to the area for three to five years. This means you need to know everything about the market the property is located in. You should have an idea of any changes in local demographics and what new businesses have come and gone. You should look at local property sales and see if homeowners are buying in your area. Something as seemingly unconnected as the strength of the school system impacts homebuyer demand which can influence business sales. An individual commercial piece of land is only as good as the market it is located in. With any commercial sale market knowledge is critical.
- Numbers. One of the reasons that investors stay away from commercial real estate is the increase in numbers. Figuring out cash flow on a single family property is fairly straightforward. When extra units get thrown in the mix the numbers are more difficult to calculate. In commercial real estate there are a handful of important formulas you should be aware of. Items like net operating income (NOI), cap rates and cash on cash return will give you a much better sense in the strength of a deal. These terms may sound foreign but in reality they are much more basic then they sound. In addition to formulas there are a greater number of expenses you need to know. The property taxes, insurance, management fee and utilities will all be increased based on the exact number of units. If underestimating one of these has an impact on a single family property it is even more magnified on a commercial piece. The best way to understand the numbers is to reach out to a local commercial real estate agent and ask for a template or a pro forma sheet for you to review.
- Financing. Loan financing for a commercial property has some similarities to a traditional investment loan but also some stark differences. Unless your credit scores are strong (over 680) you will have a tough time getting the ball rolling. From there you also need significant down payment of anywhere between 25 & 30%. Debt to income ratio is important but the lender will also look at the cash flow of the property. There should be leases in place when you buy or strong cash flow potential. Almost all commercial property loan expenses are double or even triple that of a single family purchase and the process can take anywhere from 45 to 60 days. The number of commercial loan outlets is also reduced. Most local lenders only have a reduced number of commercial loan programs and products which can make approval difficult. There is a big difference in getting approved for a single family investment property and a multi-unit commercial building.
Prior to investing in a commercial property you should have an idea of your goals and how you plan on managing the building. Even the most seasoned investors need management help on a twenty unit apartment building. There is nothing wrong with getting your commercial start on a five unit mixed use property and building from there. Like anything else you do in real estate you should take your time and know exactly what you are getting into prior to getting too far.