Presently, the commercial real estate (CRE) sector is witnessing a boom, and savvy investors are keying into this. What investor would want to pass up an opportunity to enjoy long-term leases, passive income, affordable properties in booming markets, and zero or the little landlord responsibility that comes with triple net (NNN) investments, a fast-rising sector in CRE?
Whether you’re new to real estate investing or a seasoned residential real estate investor looking for a way to earn passive income without landlord responsibility, this article is for you.
Here, we’ve outlined the factors you’ll need to consider before buying a commercial real estate property.
You’ll discover the different CRE options available, how to get financing for your investment, the property valuation method to adopt, and how to compare commercial real estate deals.
These tips are vital to ensure you don’t make mistakes while searching for the best commercial real estate deals. They’ll also offer you insights into various CRE sectors to enable you to pick one that aligns with your investment needs.
After reading this article, you’ll be armed with all the information you need to start commercial real estate investing today. If you’re interested in buying commercial property as an investment, here are five factors to consider to make the best investment decision.
Learning Resources on Buying Commercial Real Estate
Before you start your journey to purchasing commercial real estate (CRE), you should follow these steps to train yourself in commercial property investing:
Educate Yourself
Although diversifying your portfolio is a vital aspect of investing in commercial real estate, you’ll need to read and become an expert on the type of CRE investing you want to engage in.
Furthermore, you’ll need a blueprint for your investment strategy. You can educate yourself on investing in commercial real estate through the following methods:
- Visit commercial real estate investment websites and blogs like NNN Deal Finder
- Read CRE books, such as Apartment Building Wealth, Real Estate Mailbox Money, and The Real Estate IRA Investor’s Guide all from the same author Dwaine Clarke
- Listen to podcasts like Investing in a Triple Net Lease Property with Dwaine Clarke and NNN Lease Cashflow
- Join real estate investment forums and groups, attend online events like the Real Estate Masters Summit
- Network and enter discussions with other investors
Choose a Property Type
After educating yourself on CRE investing, the next step is to choose an investment property type.
For instance, if you’ve been a residential investor and are considering investing in commercial real estate it’s best to evaluate the different property types available under commercial real estate investing.
That way, you might discover that some options like triple net properties are better than buying multifamily homes due to their passive nature. Investors with triple net or NNN properties don’t bother about landlord responsibility and property management.
If you’ve decided on buying commercial real estate, the following are five primary commercial real estate types to invest in:
Retail
Retail properties are real estate buildings used to market consumer goods and services with leases that include gross, single net, double net or NN, and triple net, also called NNN.
Retail leases, especially triple net leases, are long-term, up to 20 to 25 years. NNN Investors enjoy passive income with little or no property management responsibility.
As a matter of fact, tenants in a triple net investment like Starbucks, Rite Aid, or Wendy’s handle all the property operating expenses, including insurance, property maintenance, and taxes, plus the utility bills.
If you plan on investing in triple net (NNN) properties; you’ll need a seasoned broker like Dwaine Clarke’s NNN Deal Finder. Visit their website for a free, carefully tailored list of available triple net properties and get started earning a passive income.
Office
An office building can be a skyscraper downtown, a commercially zoned house, or an attorney’s office.
Industrial
An industrial property comprises distribution centers like Amazon, warehouses, and storage units, the largest industrial CRE sector.
Hospitality
Hospitality real estate comprises motels and hotels that serve leisure and business travelers. Short-term rentals fall under this category too.
Understand the Investment Math
After determining the commercial real estate property type to start your investment journey, it’s time to understand investment maths thoroughly.
Start by getting your underwriting tools ready. You can use some online templates or create one yourself. Some investors use an Excel spreadsheet that includes where to type in items like estimated rehab, financing, purchase price, and projected rent. The spreadsheet will disclose the expected returns, allowing the investor to decide if it’s a great deal or not.
Check for any “back of the envelope” formulas you can use to immediately discover if a commercial real estate investment is worth underwriting or not. A “back of the envelope” formula will give you the red or green light and can be any single metric like the price of an investment property per square foot.
That’s why savvy investors hire commercial real estate brokers with in-depth knowledge of market trends like NNN Deal Finder. As an experienced broker, we will provide you with a free detailed list of available properties while working with you on your budget. Reach out to us now through our website to get a copy!
Financing Options for Buying Commercial Real Estate
Another factor to consider when buying commercial real estate is the available financing options for CRE investors. The following financing options are available for you to choose from:
Agency Loans
These are government-sponsored companies, generally called GSEs or agency lenders like Freddie Mac or Fannie Mae. These government loan programs were created explicitly for financing multifamily properties. That way, Americans can enjoy affordable and abundant rental housing.
These programs create specific standards for getting their loans. Once you meet those standards, the loan is sold to you in bonds.
A loan enjoys more credibility coming from Freddie Mac and Fannie Mae with an “implied guarantee” that if the payment stops or underlying collateral goes sour, the government will pay the bond debt.
Life Insurance Companies
A life insurance company can provide low-leverage loans on commercial real estate properties with stable cash flows. Those who qualify will enjoy the lowest interest rates. Life insurance companies offer incredibly low-risk loans. Hence, they can easily extend the deal’s interest.
Nevertheless, there’s a downside to using a life insurance loan: they’re very low leverage and less flexible than getting bank loans. More so, life insurance companies often prefer doing larger amounts like $20 million and above. However, there are a few exceptions.
CMBS Loans
A commercial mortgage-backed security loan or CMBS for short is structured through large banks. These large banks will package and sell loans as bonds to investors. CMBS loans are for all property investments, unlike agency loans that are strictly for multifamily properties.
However, CMBS loans are longer-term loans on investments with stable cash flows. Moreover, there’s less need for an active lender.
The disadvantage of getting a CMBS loan is inflexibility, regardless of the reason. It’s challenging to get them to modify your loan according to your needs. Hence, they’re one of the least popular commercial real estate investing financing options.
CMBS loans are used mainly in secondary and tertiary markets where life insurance companies and banks are disinterested in their investment.
SBA Loans
Small Business Administration or SBA loans are approved government loans with two separate loan programs to finance commercial real estate. They are:
SBA 7A Loans
These loans help an investor increase their creditworthiness. An SBA 7A loan reduces risk through its implied guarantee that the government agency will repay the loan when the borrower cannot. While it’s best for small deals and easily obtained, they come with high-interest rates.
SBA 504 Loans
These loans are for larger projects of above $1,000,000. However, the borrower must have ten percent or more equity in the deal. The SBA will then lend about 40 percent before a traditional lender issues the balance.
SBA loans aren’t for buying multifamily properties. They’re often for owner-occupied CRE, meaning that you’ll use the property for business. Unlike 7A loans, the 504 interest rate is lower.
Debt Funds
Commercial real estate debt funds are a private equity-backed capital pool with a specific target and mandate to produce collateralized loans for qualified real estate borrowers. Debt funds always opt for the investment type they’re familiar with, especially if it’s a higher-risk deal, so the originator can step in and own the property if a borrower defaults on payment.
The interest rate is also higher than the market average, and the loans are often short-term three-year loans. However, you can choose to extend it to buy more time to stabilize the property or get permanent financing from a traditional lender, CMBS loan, or life insurance.
Forming a Well Qualified Team
One thing you mustn’t forget to do when buying a commercial property for investment is forming a well-qualified team of brokers, contractors, commercial real estate attorneys, and property managers to help you do the following:
Choose an Asset Type
A broker well experienced in buying commercial real estate properties will help you choose an asset type that best suits your investment needs so you can avoid the numerous “shiny objects” in commercial real estate.
Arrange Your Asset Management Plan
Your team will also help you arrange your investment strategy, otherwise called your asset management plan. The asset management plan comprises handling the lease-up, providing financial reports, performing any renovations, and managing the site.
You also get to help oversee your team’s effort and keep track of the project. You’ll need to have measurable action points for your team members based on their responsibilities. That way, you can hold them accountable.
Owning multiple assets means you might not have the chance to visit each property every day, week, or month, so you’ll need these reports to stay updated.
Construction and Renovation
Your contractor will help you come up with a renovation plan for the property if necessary. If you’re constructing from scratch, you’ll need architectural, construction, and civil engineering plans for the project.
Suppose you wish to take the BRRRR route and replace the flooring or paint only the exterior. You’ll need to start those updates quickly after closing the property.
Leasing to Tenants
You’ll need to work with an experienced broker here to lease the property. Suppose you bought a triple net property without a running lease, you’ll need help leasing it out.
Your leasing team will need to find, negotiate, and qualify prospective tenants for your properties. That way, you can focus on other acquisitions.
However, at NNN Deal Finder, you can always find a fast-food restaurant for sale like McDonald’s, a drug store for sale such as Walgreens, and even auto parts companies like AutoZone with an ongoing lease.
That way, you can earn passively from the lease without having to spend money re-leasing the property. Contact NNN Deal Finder now for a free list of available properties for sale.
Managing the Property
This is where your property manager comes in. A good property management team helps to handle tenant relations, oversee building maintenance, collect rents and utility bills, provide bookkeeping and financial services, and pays and manages the bills.
However, you’ll need to ensure you’re working with a professional property manager with a great relationship with your tenants so they renew their rent and stay on the property. That way, you save money from vacancy losses and re-leasing fees.
Preventative maintenance from the team will also enable you to save money later on, although it might reduce your cash flow in the near term.
How to Compare Commercial Real Estate Deals
Residential property is often valued for the tenant based on square footage and comparable property prices in the neighborhood. In contrast, commercial properties are evaluated differently.
One popular technique for evaluating a commercial real estate property is a cap rate comparison between the building and similar ones. You can calculate this by dividing the property’s net operating income by its sale price. Think of it as your assumed annual rate of return if you paid cash for the property.
However, regardless of how good a prospective property seems after measuring its cap rate, it’s best to check it out through another valuation method like one of the following:
Cash Flow
Cash flow simply implies the total amount you have left after your mortgage and expenses have been paid.
Net Operating Income (NOI)
The entire income from the property after the operating expenses have been paid, including loss and vacancy, but before the mortgage is paid. This amount is used to calculate the cap rate.
Gross Income
A property’s gross income is the money it brings in before operating expenses.
Cash-on-Cash Return
The cash-on-cash return is determined when you divide the cash you paid for the property by the cash flow it produces annually. It’s another way to measure your ROI.
Put Up an Offer and Analyze the Deal
Before buying a commercial property for investment, you’ll need to do the following:
Have an Action Plan
Before setting out to invest in CRE, it’s best to have an action plan. For instance, you need to ask yourself how much t you can afford to pay for a property before shopping around for mortgages. That way, you get an idea of the amount you will need to pay over the life of the mortgage.
Consider using tools like a mortgage calculator to enable you to get an estimate of your home’s total cost. You also need to ask yourself some vital questions like how many tenants are in the property and paying rent? How much do you want to make from the deal? How many rental spaces will you have to fill?
That way, you can decide if the property is an excellent investment or not.
Discover What the Insiders Know
To become a key player in CRE, think like a professional and act like one. For instance, you’ve got to learn that commercial property valuation is different from residential property.
Commercial real estate income is directly proportional to the usable square footage, unlike individual homes. More so, commercial properties come with a bigger cash flow.
Furthermore, commercial real estate like triple net investments operate on longer leases than single-family residences, ensuring greater cash flow. As an investor with a Starbucks triple net lease property, you get to enjoy a 20 year lease with a specified incremental increase every five years. Nothing beats that!
Look for Motivated Sellers
You’ll need to know how to find motivated sellers ready to sell below market price. The truth is, finding a great deal is what every investor wishes for in real estate.
A motivated seller is one with a pressing need who is willing to sell the property below market value. If the seller isn’t motivated, negotiations might be difficult.
Learn to Identify a Good Deal
Top real estate professionals know a great deal when they find one. The secret is that they always have an exit strategy because the best deals are those you can leave when you want to.
It’s good to have a sharp eye to spot any damage requiring repairs, to ensure the building meets your financial goals, and to learn how to assess risk.
Discover Key CRE Metrics
You’ll also need to learn how to measure commercial real estate key metrics when assessing a property. Investors use metrics like cash on cash to compare the property’s first-year performance with competing buildings.
Another metric to note is the capitalization rate called cap rate for short used to calculate the property’s income-producing value. Cap rates are also used to estimate the net worth of present and future cash flows in a process called capitalization of earnings.
The last key metric to know is the net operating income (NOI), calculated by evaluating an investment property’s first-year gross operating revenue before subtracting the operational expenses.
Adopt a “Three-Pronged” Approach to Property Evaluation
When looking for how to invest in commercial real estate, you’ll need to make the Internet your friend. Read classified ads, visit commercial real estate property websites like NNN Deal Finder and hire a broker to help you find viable and valuable investment assets.
Conclusion
Commercial real estate investment has many advantages, making it the preferred option for savvy real estate investors. Whether you’re a seasoned investor or beginner in the real estate market, you’ll need to apply the same sound investing principles and due diligence.
Regardless of your experience level, you’ll discover that a commercial real estate property is a great investment opportunity when you start with a detailed plan. However, you’ll need to learn the ropes first.
Undoubtedly, every investment comes with its own risk, which is always magnified when investors delve into investing without a solid plan. Thus, you’ll need to assemble a trustworthy team, consult with professionals, and try to protect your assets to avoid losses.
Are you looking to buy commercial property for investment? Contact us to get a copy of Your Simple Plan for Generating Predictable Passive Income from Commercial NNN Properties. We’ll be there with you every step of the way.
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