The Basics To Buying Your First Commercial Real Estate Investment
Today, I’m going to show you how to get started in commercial real estate investing with 5 steps to buying your first property.
In fact, it’s the same strategy that I used in 2019 to acquire 4 office buildings here in Nashville.
So, if you’re interested in commercial real estate investing, you’re going to love this step-by-step guide.
Let’s dive on in.
Step 1: Choose Your Niche And Become The Expert
You need to decide what you want to do and focus on that.
There are many “shiny objects” in commercial real estate – that’s one of the beautiful things about this industry! And while diversifying your portfolio is certainly an important aspect of commercial real estate investing, you need to dial in and become the expert on one specific type of investing, first.
Now, the most you’ll ever learn about commercial real estate is actually after you’ve done a deal – some parts of the investing process just can’t be captured in a book or video.
However, you need to have a decent understanding and road map for your investing strategy.
There are so many ways that you can go about educating yourself on commercial real estate:
You can listen to podcasts
Read commercial real estate books
Watch videos on YouTube
Have conversations with other investors. Learn from people who have done it already!
Join real estate investing groups. Joining a real estate investing group here in Nashville (REIN) was one of the first steps I took to becoming a real estate investor.
Not only do these groups offer educational classes and events, you can network with other investors to find deals.
You know what? You might even get a job in commercial real estate! That’s what I did – I got my start as an in-house leasing agent for a boutique development firm.
In the 4.5 years I was there, I learned how to build single family homes, develop townhome projects, manage office / retail / industrial properties, and how to masterplan communities!
It would’ve taken me a lifetime to learn that any other way and I got paid to do it.
Ok, so after you’ve educated yourself on commercial real estate investing, it’s time to choose a property type. And the reason that I recommend you choose your property type after you’ve educated yourself on commercial real estate, is that you don’t necessarily know which property type will be right for you before you get started.
For example, if you’re a single-family residential investor, you’ve probably heard the next step is buying multifamily. But did you know that storage units, which are a subclass of industrial, pretty much operate the same way as multifamily without the headache of dealing with residential tenants?
You may find another asset type that is more attractive to you as an investor.
Choose A Property Type
There are 5 primary types of commercial real estate that you can invest in:
That’s anything from a single duplex with two units, to hundreds of units spread out across a garden-style apartment complex.
Office buildings can be as small as a commercially zoned home housing an attorney’s office or a skyscraper downtown.
Retail real estate can be anything from that Starbucks around the corner from your house to a massive regional shopping center.
Industrial real estate is made up of warehouses and distribution centers of all sizes – think Amazon delivery!
Hospitality real estate are the hotels and motels that serve business and leisure travelers. Short-term rentals are often included here, too.
So after you’ve determined which commercial property type is right for you, it’s time to decide upon an investment strategy.
Your Investment Strategy
There are many different investment strategies and just like choosing a property type, it’s important to find a strategy that’s right for you. Depending on your goals and what piques your interest, you may find yourself:
Land banking is where you purchase larger tracts of land that are in the path of development with the hope that they will appreciate in value as the development moves your way.
Commercial real estate development is where you take raw land and re-imagine what could be constructed on that property.
Fix & Flip
Just like it sounds, fix & flip in commercial real estate investing is the same as it is in residential where you buy a property, make any necessary repairs and upgrades, and then resell it.
Wholesaling real estate is where you find a good deal, put the property under contract, and sell the contract to another real estate investor or owner-occupant.
Similar to “house-hacking” in residential, owner-occupied commercial real estate investing is where you purchase a piece of real estate where you plan to run your business.
The BRRRR strategy – this is my favorite investing strategy and one I have used time and time again. BRRRR stands for Buy, Rehab, Rent, Refinance, Repeat.
If you don’t have time to actually run and operate a deal, there are many benefits to being a passive investor in commercial real estate.
Step 2: Learn How To Underwrite Commercial Real Estate Investments
You Need To Know The Math Inside And Out
Get your underwriting tools together (you can create these yourself or you can find some templates online).
Most investors will use some variation of an Excel spreadsheet where they can type in various items, such as purchase price, estimated rehab, projected rent, and financing. These spreadsheets will then crank the expected returns for the investor on this deal.
You should also have a “back of napkin” formula that you can apply to any commercial real estate investment to determine whether or not it’s even worth underwriting.
This “back of napkin” formula can be any single metric that works for you and can give you a quick green or red light. For me, I like to look at the asking price per square foot of the investments I make. Having a background as a commercial real estate broker, I have in-depth knowledge of what market rents are per square foot. By utilizing the prices per square foot on the purchase and rent, I can quickly determine if the deal will make any money.
Now, I do recommend when you first get started that you underwrite every deal you possibly can. This way, you can actually learn what makes a deal work.
Take A CCIM Course And Work For Your Designation
CCIM, which stands for Certified Commercial Investment Member, is a designation offered by the CCIM Institute.
This commercial real estate designation is comparable to a CPA for an accountant and is basically a master-course on how to invest in commercial real estate. They teach you how to analyze project financials, research real estate markets, determine user criteria, and make investment decisions.
While this designation won’t be important for everyone, the CCIM course is pretty in-depth and you’ll walk away knowing just about everything you need to know about investing in commercial real estate.
Step 3: Build Your A-Team
Find A Broker That Specializes In Your Chosen Property Type
Get on their mailing list and review every email they send. Underwrite & tour every property that closely fits your criteria. But most importantly, have conversations with them about the properties.
Why do they like this site? What are the drawbacks? What is their anticipated OpEx?
Brokers want to bring you deals that will be successful so they can continue selling you properties in the future.
Find A Commercial Real Estate Attorney
Hiring an attorney that specializes in commercial real estate is an absolute must in my mind.
Not only do commercial real estate attorneys review and negotiate purchase and sale agreements on your behalf, they also check to make sure that the property doesn’t have any zoning restrictions, land-use issues, environmental issues, and they can also help you negotiate your loan agreements.
Find A Contractor That Specializes In Commercial Real Estate
Are you starting to catch on here with the commercial real estate specialty? Everything is different in commercial real estate than it is in residential real estate. You wouldn’t call the Fire Department to stop a bank robbery – the same goes for contractors that specialize in commercial real estate.
Your contractor will be able to walk through properties with you and help you get an idea of what the expenses will be if the property needs any maintenance & repairs – depending on your relationship with them, you may only be able to walk through while you’re under contract and not every single deal you tour.
Find A Commercial Property Management Company
Having an outstanding property manager on your side makes all the difference when you’re investing in commercial real estate. I highly recommend keeping a property management fee in your underwriting, regardless of whether or not you intend to hire a management company. You never know what could happen and if the deal doesn’t work with a management fee, it probably doesn’t work at all.
Property managers will be able to walk through and assist you during your due diligence just like a contractor would. They can help, along with your broker, point out the pros and cons for tenants and any issues that may arise during your acquisition of the property.
Build Relationships With Commercial Lenders
Commercial lenders will have specific underwriting criteria, as well, and can also help you determine if a deal makes sense. Chances are good that if you’re unable to get approved but multiple commercial lenders, it’s probably not a deal.
Buying a Commercial Building: Pros and Cons
Purchasing a commercial building is no small decision. After all, it is a lot different than purchasing a residential property. Typically there’s more money involved— and more responsibility. Whether you’re purchasing as an investment or as space for your own business, there are advantages and disadvantages to owning a commercial building.
Let’s take a look at the possible risks and rewards of buying commercial property.
Buying a Commercial Property as an Investor
If you buy a commercial property as a real estate investor, it means that you don’t intend to occupy the building. Instead, you’ll lease it out to tenants who need a space for their business.
Pro: It can be a great cash-flow opportunity.
First and foremost, real estate can be a great income source. The annual return of commercial properties is typically higher than that of residential real estate, which is great if you’re looking for investments with high earning potential. On top of that, buying a commercial building with tenants already in place means that you won’t even have to wait around to get the cash flow started.
Pro: You can establish specific lease terms.
Many, many laws govern residential real estate. There are still federal, local, and state laws in place to uphold standards and ethical business practices, but there are generally fewer rules when it comes to commercial leases. This gives you, as a landlord, a little more freedom when setting your lease terms. For example, you can request more documents from a business in order to thoroughly vet them.
Pro: Having issues with tenants is less likely.
Tenants of commercial properties usually aren’t individuals; they’re businesses. Because of this, the owner-tenant relationship will look a lot different than it would with a residential lease. Many commercial property owners much prefer the business-to-business relationship. There are several reasons for this:
- Since their location is tied to their overall brand image, a business is more likely to keep up and maintain the property.
- Businesses often bring higher credit and leases are backed by a personal guarantee from the business owner or partners.
- Businesses typically abide by daytime business hours, so you’re less likely to receive a call or complaint at inconvenient times. Bars and restaurants, among others, are notable exceptions.
This isn’t to say that you will never come across a commercial tenant that causes headaches. There are bad tenants in every real estate sector. However, the likelihood is much smaller.
Con: The upfront costs are higher.
Office buildings typically come with a higher price tag than the average home. In addition to this, commercial real estate loans have a lower loan-to-value ratio, meaning you’ll have to put a higher percentage down in order to obtain financing. Just like purchasing any other property, you’ll have a down payment, closing costs, and other fees.
Con: There can be more risk involved.
More people come in contact with a commercial property, which opens up the possibility for accidents and major damage to your property. Think of a retail store and the risks involved there— patrons can get hurt inside or outside, cars can do damage to the building, vandals can strike after hours— the list of possibilities is endless. Be sure to weigh the risks associated with the types of commercial real estate you’re investing in, and understand what your property insurance will cost and cover.
Con: You’ll likely need the help of a property manager.
The repairs and maintenance of commercial buildings are a lot different than what you may find in a house. Because of this, many commercial property owners opt to hire a property manager to handle these responsibilities.