Brokerage & Management
Commercial property investing is a lot different from residential. Financing, analyzing the investment, management and contracts are just a few things that you need to relearn when you make the progression from residential to commercial investing.
At Harper Realty, Inc. we have helped many of our customers progress from their first residential investment to large commercial projects. We will help you with triple net leases, 10 year and longer leases, national tenants and various other investment options.
Commercial properties are used for businesses or are apartments with five or more units. The logic is that owning and managing apartment buildings is a business just like properties where a business is the tenant. The first thing I always like to emphasize to prospective buyers is that everything about commercial property ownership is different from residential, including, but not limited to: how to determine value, financing, government regulations and leases.
For single-family homes, the property value is based on comparable sales. For commercial properties the value is determined by the income stream. More precisely Net Income. Net Income divided by the Price is the Capitalization Rate (CAP). When an investor has a required Return on Investment (ROI), divide the NOI by the CAP to determine the price.
If the rate of return is higher than the interest rate on the financing, the investor is earning a return on the borrowed money less principal reduction.
The lenders for residential and commercial properties are different and have different guidelines. To qualify for a home loan, the buyers income, savings, and credit carry 90 percent of the qualifying weight. For commercial loans, the property income, expenses, condition, and value carry 90 percent of the qualifying weight. The seller must be ready to disclose everything if you plan on receiving financing. Your sales contract should require the seller to disclose and provide you with all documentation describing the income, expenses, and condition of the property immediately after contract acceptance. Remember to ask for the seller's Schedule E's from their tax return. You may have to be persuasive, as they often initially say no; but it can be difficult to get financing without the Schedule E.
Many government regulations and disclosure requirements apply to residential property only. The IRS Codes are different for commercial property, where the depreciation rate is 39 years, not the 27.5 years that it is for residential. Potential commercial investors must understand that it is still, "Buyer Beware". Make sure you perform your due diligence. Look deep into the income, expenses, condition, future market conditions, proposed road widening, and anything else you can imagine that could affect the property and investment in it.
My commercial leases are extremely aggressive. Late payments become very expensive for the tenant. With rents due at the 1st of the month, I charge a late fee on the 5th; a daily fee from the 6th on; a "3-day noticeÂ fee; and, of course, the tenant pays for all costs related to collections. Collection costs can amount to the thousands of dollars if you hire an attorney. Tenants learn quickly, “Pay on time.
The lease describes the tenant and landlord responsibilities. I have determined that the more tenant responsibility, the less I have to do. My leases have the tenant pay for all improvement, repairs, maintenance, and utilities. If the tenant wants carpet, paint or any other improvement, they have to pay for it and facilitate the improvement. When the tenant leaves, the improvements remain with the landlord. It is common and easy to rent with these terms.
Triple-net leases (NNN) have the tenant pay their prorated share of (1) property taxes, (2) insurance, and (3) common area maintenance (CAM). These NNN leases are great because the net operating income and return-on-investment CAP rates are very predictable over a long period. Remember, your lease can utilize any combination of nets: N, NN, or NNN. As the property owner, you write the lease, so it is up to you to decide who pays for what.
I prefer one-story retail strip centers with a variety of tenants, from doctors to donut shops. For these types of properties, parking lot access by vehicles is extremely important. The lot must have ample curb cuts, so a driver can access the parking lot from all directions. An island in the middle of the road that restricts left turns is a major negative for this type of commercial property.
As the owner, think about using this space for your trade or business. Just like owning your own home, if you are a business owner/real estate investor, it is a good idea to own real estate where you conduct your business. Why should you pay rent when you can get others to do if for you?