In times of low interest rates and churning stock market prices, real estate investing becomes increasingly appealing. Buying and owning commercial properties, however, isn’t as simple as most residential transactions. Beyond location and price, there are numerous additional factors to consider as well as an increased need for discipline in purchasing and operating such properties profitably.
As with the stock market, too many people make real estate investment decisions for the wrong reasons. It’s easy to see the appreciation building in the marketplace and become tempted by the numbers, believing that the fundamentals don’t matter as much in a rising environment. Whether you’re seeking property for your own portfolio or for a client’s, the following habits will help you put the focus where it belongs on your return on investment.
Identify the Asset Class that Resonates With You.
Success starts with being disciplined about what type of asset class you want to invest in and what the returns should look like. That means setting specific parameters, not just jumping in because a given deal sounds good on paper. Whether you’re drawn toward single family or multifamily residential, office, industrial, retail, mini-storage or hotels, go through a thoughtful exercise of why you want to own real estate, how you will operate the property and what your expectations are from the investment.
Assess Your Appetite for Risk, Reward and Work
Net-lease deals, in which an investor buys a property with a tenant in place, can be viewed as mailbox money. You receive a check each month and run to the bank. You’re plugging into an income stream, so your risk is low, but your return will also be on the lower end of the scale, most often in the 5-6 percent cap range. In contrast, heavy touch assets may be available at a higher cap rate or per unit rate, delivering 8 percent or more return on investment. However, the leases will likely be shorter term and there will be more management responsibilities on the part of the owner. This can mean re-tenanting, rebuilding portions of the building, repositioning the property, re-working parking plans or signage and many other tasks.
Define How You Will Manage the Property
In most cases, commercial assets require a lot of active management on top of your existing work week, particularly if you choose to take on the lead role. Even if you hire a third-party manager, you will want to meet with the tenants and actively engage in the property as an owner. This allows you to be an engaged and responsible property owner while garnering the type of returns you want as an investor.
Be Disciplined About Valuation
In commercial real estate, comparable sales and listing information is more difficult to come by. There are numerous components in underwriting a deal and calculating income streams and returns. If you’re working with the right expert, they will be able to show you comparable sales and current, competitive lease and vacancy rates. This is critical. For example, if the lease in place is high and you’re calculating your return on that basis, you’re going to be paying too much for the asset. One of biggest mistakes investors make is buying into pro-forma financials versus digging deeper to obtain the actual numbers. The better approach is to assume the market will stay the same or decline, particularly if there is strong competition with newer product coming to market. In the Greater Phoenix Area, we have over 7,000 multifamily units coming to market in urban infill areas. This will make it more difficult to compete for older properties. So it is important to ensure that you are buying multifamily properties today, taking into account a potential decline in rental rates. New apartment construction may signal that the market is hot, but it’s also going to be tougher to compete because prospective tenants will be drawn to the newer properties.
Do Your Physical Due Diligence
With residential properties, most purchases are made with a turnkey assessment by a home inspector, but on the commercial side it’s difficult to find a single entity to assess all of the building components. Because the systems are more sophisticated – and because of the greater dollar investment – you may need to enlist electricians, HVAC contractors, roofing contractors and other specialists.
Vet Your Third Parties
Brokers and other experts should be able to answer very strategic questions as far as their experience in a specific asset class and submarket. How much work do they do with investors? How do they split their time between representing owners versus buyers? Are there any conflicts of interest?
Ultimately, investing in commercial real estate is a team effort – it’s simply too complex to expect even the most dedicated do-it-yourselfer to go it alone. From valuation, contract negotiations and acquisition to lease-up, management and eventual sale, enlisting experts in specific fields can ensure that your investment delivers appropriate returns.