There are many reasons you might first think about investing in commercial real estate. You might notice how popular a new shopping area has become. You might learn how a 1031 like-kind exchange can help you build a legacy of wealth that you can pass to the next generation. Or you might simply become attracted to idea of investing after closing on a couple of homes.
Whatever first gets you thinking about commercial real estate investment, it’s important to understand that buying commercial real estate is significantly different than buying residential real estate. It’s a good deal more complicated, and there are more risks involved. You can mitigate the risks by working with the right people and asking the right questions. Here are four of them.
How should you form your business?
When you invest in commercial real estate, you’re hoping to make money off your property. That’s a business. Most small businesses are sole proprietorships, which involve the least amount of paperwork, but a sole proprietorship may not be the right business entity for your real estate investment. You may want to pool your money with other investors, attract more investors later, or limit your liability.
The right business structure can help you do all these things, even as it protects you against the partnership disputes that Forbes says are among the most common mistakes in commercial real estate.
What should your due diligence entail?
Experienced commercial real estate investors often point to bad due diligence at the root of other investors’ problems. Commercial real estate is valued differently than residential real estate, and buyers have fewer protections. The prices of residential properties are usually based off the price of similar properties nearby. But commercial properties are more about the cash flow.
Investors want to work with professionals who can offer good valuations, as well as help them complete all the other key parts of their due diligence. These may include checking on the existing leases, investigating the title, performing competitor research, checking the building’s condition, and making sure that the property is clear for land use and zoning permits.
What will you cover in your purchase agreement?
Unlike residential purchase agreements, which tend to follow strict guidelines, commercial real estate purchase agreements can go in all directions. You can negotiate pretty much every term, and the agreements can range from just a few pages to more than 200.
It’s generally wise to work with a real estate attorney who can help you make sure the agreement does what you mean for it to do. You want to make sure the property is properly defined, that you have time for your due diligence, that you leave yourself the necessary contingencies, and that you get estoppel certificates for each of the tenants (sometimes referred to as rental information questionnaires).
What about the tenants?
Since the way people commonly make money from their commercial real estate investments is by renting them out, it’s important to understand the existing leases and how you’ll create new ones.
As with your purchase agreement, your leases are almost entirely up for negotiation. And the terms to which you agree will have a huge impact on every aspect of your future business, including your relationships with your tenants and the amount of time you invest in the property each day. As a result, you want to view your lease agreements not just from a legal standpoint, but from a strategic one as well.
Commercial real estate investment is a “team sport”
Because commercial real estate investment demands so much more time and expertise than residential real estate, you might think of it as a team sport. At least, that was what Forbes suggested in an article late last year. This means more than pooling your resources with other investors. It means working with a team of lenders, contractors, attorneys, property managers, and other professionals who can help you toward your goal. There are a lot of upsides to winning in commercial real estate, but winning requires a good team—especially when you’re first getting started.