Buying commercial real estate? Everything you need to know

If you’re just starting out on your journey to buying your first commercial real estate property, this is everything you should consider and educate yourself about before jumping in. 

Commercial real estate is one of the most competitive and dynamic industries around—which makes it both exciting and daunting. On top of the difficulty of even finding the right property, purchasing commercial real estate requires a certain wherewithal. Additionally, each local area has its own unique qualities, so there’s no one-size-fits-all guidebook to help you fully understand what you’re getting into. 

But there are several ways you can prepare yourself to get into the commercial real estate market. Below, we outline everything you need to understand in order to get started—and how to go about the learning process. 

Understand Your Budget 

The first thing you need to get clear on is how much money you have to spend and how you plan to finance your commercial property purchase. Real estate is extremely expensive, and there’s no sense in looking at the market or property types until you have a good grasp on your purchase power. 

The best way to understand what you can afford is to talk with both a financial advisor and a lender. Lenders are eager to pre-qualify what you can afford since they get commission with every deal, so it’s a good idea to also speak with a financial advisor about your broader financial goals to understand what’s best. 

Know Your Financing Options

Your budget will largely depend on how you choose to finance your purchase, and vice versa. There are a few ways to go about this: 

All Cash

Making an all cash offer on a real estate purchase means that you don’t need to borrow money to finance your investment. It’s a great option if you have enough funds to do so, since you would have to pay interest on any loan you take out, thus increasing the amount you pay for the property. You also won’t have monthly mortgage payments, decreasing your monthly costs, and you eliminate the risk of defaulting on the loan in case you fall on hard times. However, considering the high price of most commercial real estate, most people don’t have the cash on hand to make this kind of offer.  

Loans

Taking out a loan to finance a commercial real estate purchase is the most standard approach for new investors. This allows you to buy property and pay for it over a set period of time. You do, however, need to have enough cash for a down payment, which can be anywhere from 10-20% of the overall cost of the property. You’ll also have monthly mortgage payments that include interest and a portion of the principle amount. 

Lease-to-own

Down payments are often too expensive in their own right for many people, and in that case, a lease-to-own model can be a great option. Lease-to-own means that you can earn a down payment while leasing your property at the same time, allowing you to secure your space and your financing all at once. If you own a small business, withco is happy to help guide you through this process, and may be able to pre-qualify you for our lease-to-own model should your business’s finances be a fit. 

Research Local and National Markets 

Once you understand what you can afford, you’ll need to educate yourself on the current real estate market in the area you’re interested in investing in. National brokers and real estate service providers like Colliers, Coldwell Banker, JLL, and Newmark provide research on areas where they’re active as well as national data.

But there is simply no better way to understand a local real estate market than to talk with people who actually have boots on the ground. In most cases, that would be local real estate brokers. They can help you understand what inventory is available in your area based on your budget and goals. It helps if you can get insights from more than one. Note that when you’re ready to purchase, anywhere from 3-6% of your investment will go to the broker you work with—so make sure you work with someone you trust. 

Find Your Property Type 

Your local brokers will likely break down your options into several categories of property types, and it will be important to understand the ins and outs of each one. Research the risk return profiles of different property types in your area—some are lower risk than others, but what you choose will ultimately depend on your business goals. 

There are nuances to each property type, but they can typically be broken down into the following: 

1. Multifamily: Apartments, townhouses, duplexes, you name it. If it’s a structure that can house more than one family in separated units, it’s a multifamily property. Multifamily properties can often be combined with retail or office properties if the structure contains a storefront.
2. Office: It’s simple: this type consists of any kind of property that people lease to work out of, but don’t see customer foot traffic. They can range from bungalows that house local law offices to big city skyscrapers with multibillion dollar workforces.
3. Retail: Boutique clothing shops, department stores, restaurants, coffee shops—any place where goods and/or services are exchanged for money with a clear storefront. Retail properties are for businesses who rely on foot traffic.
4. Industrial: Think warehouses and distribution centers. These are usually larger structures and often contain tenant’s machinery or equipment.
5. Hospitality: Anything related to the travel industry is related to “hospitality.” Think hotels, motels, and even short-term rentals.
6. Mixed Use: A mixed use property combines one or more of any of the above categories (though a combination with an industrial component may be harder to find). These dynamic properties can often offer multiple income streams.

Consider Renovations and Operating Costs 

No matter what type of property you choose, you should have an understanding of what it will take to keep the property up to a good standard. Will you need to renovate the property or make updates to equipment like HVACs? 

Know that every property you buy comes with ongoing operating costs and expense requirements, including taxes, maintenance fees, utilities, and more. You can typically find this information about a particular property in the current commercial lease agreement 

Understand Capitalization Rates

Knowing what it will cost to run your property with all monthly/annual expenses will help you understand how profitable your commercial property is. The “capitalization rate” or “cap rate” is calculated by dividing a property’s net operating income by the current market value. Cap rates can help you determine what percentage of our property’s value is profit.

Know Your Lease Structures 

If you’re buying commercial real estate, whether to use for your own business or to lease to another company, it will be important to understand the different types of lease structures for commercial properties. The most common types are: 

• Gross Lease/Full Service Lease
  • The tenant’s rent covers all operating expenses for the property, including property taxes, property insurance and utilities.
• Net Lease
  • Tenant pays a lower base rent while covering operating expenses like property taxes, property insurance, and utilities. Net leases can be either “double net” or “triple net” (more on this later).  
• Modified Gross Lease/Modified Net Lease
  • A combination of both a gross lease and net lease, where the lease is negotiated on a case-by-case basis between the tenant and the lessor. 

Become a Tax Benefits Expert

One of the best reasons to purchase commercial real estate is the tax benefits that come along with it. When determining what you are comfortable spending on commercial real estate, you should definitely take into consideration the immense value that owning real estate brings to your tax deferment and deduction options. This includes deducting your mortgage interest, value depreciation of the property, and any renovations or upgrades made to the property. 

You should speak with a seasoned financial advisor who can spell out what this means for you and your property specifically, but having an understanding and making a plan for your taxes when it comes to commercial real estate is always a good idea.