Purchasing A Commercial Property

Buying Commercial Property For Beginners: How To Start

ASHLEY KILROY7-MINUTE READ

FEBRUARY 15, 2022

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New investment opportunities pop up every day for bright entrepreneurs. From cryptocurrency to stock to bonds, it’s a wide world out there.

 

But what about sinking your teeth into a physical asset? For those who want to invest in something tangible with the potential for growth or passive income, you may want to consider buying commercial property. Here’s how you begin.

What Is Commercial Real Estate?

Residential property only includes single-family homes or those with up to four units. Usually, only families or individuals lease them. But commercial real estate (CRE) is generally for business purposes, including five or more units.

 

You can break commercial real estate into five main categories:

  • Multifamily: Essentially, they are residential properties with more than one unit, like duplexes, garden apartments, or assisted living.
  • Office space: They’re designated as low-, mid-, or high-rise based on size and allow for multiple tenants. Examples include medical offices and suburban office buildings.
  • Retail: This real estate is designated for businesses that sell goods or services to consumers. They’re usually located in places conveniently accessible, with examples being regional malls and strip shopping centers.
  • Industrial: These properties range in size, like office spaces, and they host industrial operations, such as heavy manufacturing or light assembly.
  • Hospitality: This covers establishments that service travelers, whether for meals, accommodations, or entertainment, like hotels and short-term rentals.

Commercial office properties face further classification, broken into three gradings:

  • Class A: Represents the highest-quality buildings available. They’re typically newer with top-tier construction, situated in the best location.
  • Class B: Can still be high-quality properties, but usually older and lower-priced compared to Class A. Many investors flip or restore these.
  • Class C: Are generally distressed and older. They require maintenance and lack an attractive location.

How To Get Into Commercial Real Estate

Figuring out how to buy commercial property isn’t exactly like buying a single-family home. The experiences differ in more ways than one. The costs, for example, can be steep with commercial real estate, and it may be harder to secure funding. In addition, if you don’t already have tenants, then it’s up to you to cover expenses during lengthy periods in-between.

 

Not only that, but valuation for commercial property is often difficult. It’s generally harder to find comparable properties for commercial real estate than residential. Because of differences like this, investors should be careful before purchasing.

1. Define Your Motivation

While buying commercial real estate can be a worthwhile investment, plans tend to fall through if you don’t have direction. So, it’s important to reflect on your reasons behind buying commercial property. If you want to narrow down your motivation, consider asking yourself:

  • What is a successful financial return to me?
  • Who do I hope to impact through my investment?
  • What are my long-term and short-term goals?
  • Do I want security for me and/or my family?

Buying Commercial Property For Personal Use

Sometimes, investors benefit from real estate in more ways than just financially. Others purchase a property for personal use. One method is the owner-occupied commercial real estate (OOCRE) investment strategy. In this, the owner uses the property to conduct business operations.

 

OOCRE affords you tax advantages, like the ability to depreciate and deduct annual interest on the loan. In addition, owning the property allows you to build equity, which you can sell for more later. Or, you can continue using the property as an income stream through leasing. It’s also much easier to manage the property on-site and control the tenant selection.

 

However, there are some stumbling blocks. More costs may fall in your lap, such as repair and maintenance. Conflicts of interest can also arise, making it difficult to collect rent. Some tenants avoid properties occupied by owners as well.

 

Before buying commercial property for personal use, check zoning laws. Certain limitations may apply to specific real estate, like office buildings or other commercial-designated spaces.

Buying Commercial Property For Investment Purposes

Buying a commercial building as an investment property comes with its perks. According to Bank of America, commercial property returns range between 6% – 12% annually; that’s higher than the average on single-family residential properties (around 1% – 4%). There are also tax advantages, cash flow opportunities, and equity appreciation when you buy your commercial property.

 

Investors employ a variety of tactics depending on things like financial goals and timeline. Here are some of the most common real investing strategies they use:

  • Land banking: The process of purchasing and holding land. Investors do this to protect their money, since it gets tied to a physical and fixed asset, and grow it. They may sell it or develop it in the future.
  • Development: An investor buys raw land to build on, sometimes after waiting for its value to grow. The direction of development, like condominiums versus commercial, depends on zoning laws.
  • Fix and flip: This strategy involves buying property, renovating it and then reselling it for a profit. Investors usually purchase poorly maintained land at a discount.
  • Wholesaling: A short-term real estate investing strategy where the wholesaler buys a contract from a property seller, typically below market value. Then, the wholesaler sells or assigns the contract to an interested buyer.
  • BRRRR: This acronym stands for Buy, Rehab, Rent, Refinance, Repeat. Essentially, it’s a passive income strategy that involves flipping a property to rent out to tenants. Once the owner pays the mortgage and builds equity, they can refinance the property to fund future real estate investments.
  • Passive investing: This strategy is for investors who don’t want to be directly involved. Instead, they put capital into a real estate deal through the stock market, crowdfunding, or partnering with a more active investor.

2. Secure Financing From A Lender

Finding a lender for your commercial property early on is essential. Compare several lenders before you settle on one, though. While you want to secure financing, you should ensure your lender promises what you need. They should offer options according to your credit score range and at an affordable interest rate. Also, ask them about possible fees and penalties so that you know ahead of time.

 

Look out for the loan-to-value (LTV) ratio, or how much they’re willing to loan, and whether they ask for collateral as well. A recourse loan lets the lender go after additional personal assets if you default. Whereas a nonrecourse loan only gives them the option to seize agreement-specific collateral.

 

As you ponder purchasing a commercial property, you may wonder about your lending options. Some of the most common are permanent loans, SBA loans, bridge loans, and hard money loans. It’s important to note that Rocket Mortgage® does not offer commercial property financing.

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