COMMERCIAL LOAN GUIDE
FAQs – Questions to Ask Before Investing in Commercial Real Estate
Well-selected and well-managed commercial property investments provide investors with capital growth and high net yields. However, the wrong property can quickly eradicate even the most robust portfolios and potentially wreak havoc on investors’ finances. This is why it’s crucial to think about key considerations before putting money into any commercial land or building.
Asking the following questions can help ensure that you are choosing a high-quality and highly secure investment:
Is there sustained demand for the property?
Investing in commercial properties means targeting specific tenancy demographics. Those tenants have changing patterns and preferences that will affect the viability of the investment.
The asset may be in high demand right now, but is that demand sustainable? Sustainability will ensure that the investment can remain viable and attractive over the long term. It also provides ease of exit while maintaining yields and improving capital growth potential.
Let’s say you want to put money in student housing. Is the location critically under-supplied to ensure that demand will continue to be high for many years?
The demand in that city might be high at the moment, but beware—new developments will saturate the market and force demand to waver at some stage.
Make sure you have enough time to make money from the investment before this happens.
Is the property in a great location?
When it comes to location, commercial real estate investing rules are slightly different from residential investing. Cities that are great for residential properties are not necessarily profitable for commercial investments like self-storage, car parks, or student housing.
As an investor, it’s your responsibility to do thorough due diligence to determine whether a location—as well as a specific positioning of the development within that location—will attract constant high occupancy over the long term.
Also Read: Commercial Real Estate Loan Terminologies
What is the value of the land?
Many new investors assume that properties generally become more expensive over time. This is not always true—especially in commercial real estate.
More than the value of the building, you should be looking at the value of the underlying land.
Buildings generally go down in value because of maintenance requirements and deterioration. The structure will eventually require replacement, too.
This is why savvy commercial property investors always take into consideration how much the underlying land is worth. After all, It will retain the majority of an investment’s value in that land. This is especially true in gentrifying areas. For example, some industrial sites that are close enough to the city may eventually be ripe for redevelopment, increasing the price of the land. It’s important to reconsider whether or not you should proceed if the ‘dirt’ has no value.
Is it leased or vacant?
The value of an asset is heavily related to the income derived from and the length of its lease. Leases usually last for 5 to 10 years, sometimes longer. The length is important, but so are the terms.
Make sure to review the lease agreement to determine if the tenant is responsible for the costs of operating and owning the property on top of rent. Do the math to see how much of the maintenance costs and property taxes can be recovered from the tenant.
It would help if you also looked at how strong the tenant is. Multinational or national brands are preferable.
You can’t go wrong with a profitable and recognized business that is not likely to close shop—and is unlikely to relocate once they have established themselves in a location.
Is the property specialized?
Industrial properties, in particular, usually have features designed for special use. Such features are beautiful for certain businesses but are not needed by others.
For example, large gantry cranes are essential for manufacturing businesses but are not required for distribution or warehousing. Such specialized features will affect the types of potential tenants you can attract and is a key driver of leasing demand.
Are there any other properties like it in the same area?
Check if the type of property is in high supply in the city or locality. How many other equivalent spaces are in the same area? Check the properties of your competitors and their levels of vacancy.
What is the exit strategy?
Successful commercial real estate investments have versatile exit strategies. This flexibility is best achieved with long ‘guaranteed income’ periods that provide investors the option to leave at any point in the investment cycle while giving buyers attractive conditions on a proven and fully operational development.
The scenario also encourages healthy capital growth. It’s hard to find this kind of versatility in investments with shorter ‘guaranteed income’ periods.
Does the property suit your investment objectives?
In their desire to quickly grow their commercial real estate portfolio, some investors forget to ask if the investment truly suits their goals. What place will it serve in your existing portfolio?
Remember that a good CRE investment for one investor will not necessarily fit another.
What risks come with investment?
A healthy amount of pessimism is required in investing, so think about the worst possible scenario. What is the absolute worst thing that can happen?
Ask yourself what the impact of such an event will have on your portfolio and your finances—and what measures you can put in place to dampen the blow.
Depending on the situation, it may be a good idea to set up a third-party, no-asset shell company and use it to underwrite guarantees.
Mitigating risk is one of the most important aspects of ensuring the success of a CRE investment, after all.
How will you finance the investment?
Lastly, you must get the right type of financing for the property. Is it appropriate to use bank financing? Are you thinking of taking out a hard money loan? An unlisted property trust? A stated income loan?
Whichever way you go, buying a commercial property means spending large dollar sums. The lender will want to know if you have the financial literacy, sophistication, and expertise to buy the asset and manage it.
The right financing will enhance the returns on your investment. Make sure you use and structure it properly.
Do your due diligence before investing in a commercial property. Asking these questions can go a long way in determining whether a deal is profitable, secure, and, most importantly, suitable for you as an investor.
It’s always a good idea to talk to a professional commercial real estate consultant about any questions you might have, regardless of how silly it sounds.
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