Key Takeaways:
– Investing in real estate can involve residential or commercial properties
– Commercial real estate investing can be intimidating, but similar to residential investing
– Market research and financial analysis are important before pursuing a commercial property
– There are different types of commercial properties to consider, each with their pros and cons
– Leases on commercial properties are structured differently from residential leases
– Making an offer on a commercial property involves negotiating terms through an LOI
– Due diligence, or feasibility period, is crucial in commercial real estate transactions
– Priorities during due diligence include inspecting the property, reviewing financial records, conducting tenant interviews, reviewing the title report, obtaining financing, and engaging an attorney for legal review
– Commercial transactions tend to take longer than residential transactions
– Despite the complexity, with experience and the right team, commercial real estate investing can be straightforward.
BiggerPockets:
Investing in real estate comes in many different shapes and sizes. Most people focus primarily on residential real estate throughout their real estate investing journeys, which include single-family homes, condos, and small multifamily properties. Other investors choose to take the leap into investing in commercial real estate, which can be very intimidating at first.
Over the past few years, I became one of those investors who took the plunge into commercial real estate. My first deal was a 2,000-square-foot medical building, and my second was a much more intimidating 7,000-square-foot office condo unit.
After having bought, rented, and sold both of these properties, my biggest takeaway is that commercial real estate investing is very similar to residential real estate, with one big exception: the due diligence period, which provides a lot of possible ways to mess up.
Pursuing a Commercial Property
The process of buying a commercial property starts with standard market research and financial analysis. Before you even write an offer, consider the location you will be buying. When picking a location, you need to look at demographics, market trends, inventory, and demand.
Unlike residential investing, your options are quite broad when pursuing a commercial property. Property types include:
- Industrial
- Medical
- Multifamily
- Office
- Retail
- Self-storage
There are pros and cons to each of these different asset classes, and deeply understanding your market is critical to ensuring you pick the type of property that meets your budget and risk tolerance.
In addition, the structure of leases on commercial properties is very different from residential leases. The biggest reason for this is that when buying a commercial property, your tenant will be a business compared to an individual, a couple, or a family.
Making the Offer
Once you identify the area where you want to invest and the type of property you would like to buy, and you find a specific property that meets your expectations, it’s time to make an offer.
Making an offer on a commercial property starts with an LOI (letter of intent). These LOIs are used to negotiate mutually agreeable terms with the buyer and seller, including the purchase price, earnest money deposit, and buyer contingencies.
Often, the LOI will be passed back and forth several times before both parties agree on terms that meet their expectations. Once both parties agree, the deal is formalized with a purchase contract.
Navigating this phase and the next phase of the process will be more complex than you’re used to. Writing an LOI, submitting an offer, and entering due diligence should all be handled with the direction of a qualified commercial real estate broker and a real estate attorney.
Due Diligence (AKA Feasibility)
Much like a residential transaction, when both parties execute a purchase contract, the title company will open escrow. This starts the clock on your due diligence window, which in commercial transactions is more commonly referred to as your “feasibility” period.
The feasibility period in a commercial real estate transaction is a very important phase where you, the buyer, will conduct in-depth due diligence on the property, tenant, and financials to determine whether the deal meets your investment objectives. This window of time works similarly to your due diligence window on a residential transaction, but it is much more involved.
Your priorities during the feasibility period will include the following.
Inspecting the property
This sounds straightforward, and it is. You need to engage qualified inspectors to thoroughly inspect the subject property. Just like when buying a house, your inspector will inspect the physical condition of the building, look for structural issues, and review the state of the major systems like plumbing, electrical, and HVAC.
Reviewing financial records
The financial records of the property should all be made available to you as soon as you open escrow. This includes tax statements, lease agreements, P&L statements, and a balance sheet. This package should give you a better grasp of the property’s financial picture.
Some owners aren’t the best at bookkeeping, so there might be some holes in the information provided to you. It will be up to you as the buyer to fill in the gaps and determine if the deal still meets your expectations from a financial standpoint.
Tenant interviews
If there is a tenant (or tenants) in place, ask your broker if it is customary to do a tenant interview in your market. This will help you get a better grasp on how the tenant feels about the building and their lease and whether they will be likely to renew when their lease expires.
Title report
You will receive a title report from the title company, and it is really important to review this report to understand if there are any encumbrances, liens, disputes, CC&Rs, or easements. Any of these items could affect your ownership or future property use.
Obtaining financing
By now, you should already have a few lenders lined up who would be willing to finance this deal. During your feasibility window, though, you will need to provide all of your financial documents to your lender and get final approval on your loan. The last thing you want as the buyer is to be a week away from closing only to have your financing fall apart.
Attorney review
Engage a real estate attorney early to help review all legal documents related to this transaction. They should be looking at the purchase agreement, contracts, lease agreements, and financial statements. Your attorney will ensure your legal interests as a buyer are protected.
Resale consideration
During this feasibility period, you should also consider the property’s potential for resale in the future. Talk with your broker about the market trends, appreciation potential, and factors that might influence the property’s future market value.
Closing on the Deal
Commercial real estate transactions, from start to finish, tend to drag out longer than residential transactions.
In my experience, I was given a 30-day feasibility window (compared to a 10-day due diligence window on my residential transactions), and then I was given 60 days after offer acceptance to close. That gave me plenty of time to complete my due diligence and get my financing in order prior to closing.
The due diligence window can be overwhelming and make commercial transactions daunting, but it shouldn’t scare you away from doing a commercial deal. If you have some residential experience under your belt and the right team by your side, you’ll find the process to be pretty straightforward.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
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Property Chomp’s Take:
Investing in real estate can be a lucrative venture, and while most people tend to focus on residential properties, there is a whole world of opportunity in commercial real estate. As someone who has ventured into commercial real estate investing, I can tell you that while it may seem intimidating at first, it is not as different from residential real estate as you might think. The key difference lies in the due diligence period, which can be a potential minefield if not navigated carefully.
The process of buying a commercial property starts with thorough market research and financial analysis. Unlike residential investing, where you typically have a limited number of property options, commercial real estate offers a wide range of property types to choose from. These include industrial properties, medical buildings, multifamily properties, office spaces, retail spaces, and self-storage facilities. It is crucial to deeply understand your market and determine the type of property that aligns with your budget and risk tolerance.
Another major difference between residential and commercial real estate is the structure of leases. In commercial properties, your tenants will be businesses rather than individuals or families. This means that the lease agreements will be different, with various terms and conditions specific to commercial rental properties.
Once you have identified the location and property type you want to invest in, it’s time to make an offer. Making an offer on a commercial property typically starts with a letter of intent (LOI). The LOI is used to negotiate mutually agreeable terms with the buyer and seller, including the purchase price, earnest money deposit, and buyer contingencies. This process can involve several rounds of negotiations before both parties reach an agreement and formalize the deal with a purchase contract.
The most critical phase in commercial real estate investing is the due diligence period, also known as the feasibility period. This is where you, as the buyer, conduct thorough due diligence on the property, tenant, and financials to determine whether the deal aligns with your investment objectives. The feasibility period is similar to the due diligence period in residential transactions but is typically more involved and complex.
During the feasibility period, your priorities will include inspecting the property thoroughly, reviewing financial records, conducting tenant interviews (if applicable), reviewing the title report, obtaining financing, engaging a real estate attorney to review all legal documents, and considering the property’s potential for resale in the future. These steps are crucial in ensuring that you make an informed decision and protect your interests as a buyer.
Closing on a commercial real estate deal typically takes longer than residential transactions. The feasibility period is usually around 30 days, and then you have an additional 60 days to close the deal after offer acceptance. This extended timeframe allows you to complete your due diligence, secure financing, and ensure everything is in order before closing.
While the due diligence period in commercial real estate can be overwhelming and complex, it should not deter you from pursuing commercial deals. With some residential experience and the right team by your side, the process can be relatively straightforward. It is essential to work with a qualified commercial real estate broker and a real estate attorney who can guide you through the process and ensure that you make informed decisions.
In conclusion, investing in commercial real estate offers a world of opportunities beyond residential properties. While there are differences in the due diligence period and lease structures, the overall process is similar. Thorough market research, careful analysis, and a diligent due diligence period are key to successful commercial real estate investing. So, if you’re ready to take the plunge, do your research, assemble your team, and start exploring the world of commercial real estate investing.
