You already know the importance of due diligence when investing in commercial real estate in your area. Investors must ensure that they make the right decision when purchasing commercial property. In addition, investors must research every commercial asset to provide the best returns.
Although thorough due diligence can take a lot of research and background work, it is not impossible to know certain information from the beginning depending on the investment amount. Therefore, we have listed the five questions investors should ask when purchasing commercial property.
Why is this commercial property being sold?
There could be many reasons why a commercial property is being resold. Some are more appealing than others. Many legal and financial liabilities can be transferred to the subsequent owners, including costly repairs or liens. If a commercial property is in serious trouble and not performing well, why wouldn't you want to sell it as well? It is essential to ask the seller why they are selling.
A word to the wise: We have found that you should ask different people several times because you may get varying answers.
Who are the current tenants of this property?
The type of commercial property will determine whether there are currently tenants in the building. Investors will need to have information about the current tenants and the terms of their leases to assess the risks.
Buyers should request a rent roll, tenant credit file, and payment history. The rent roll will give information about the tenant, such as how much they pay rent, whether they pay ordinary expenses, and the lease terms. You can find out which potential tenants you may need to go by looking at their credit history and payment history.
Can I get a pro forma?
A pro forma is required for any investor who plans to purchase commercial property. A pro forma is a document that includes expenses such as standard area maintenance, utilities, and income information.
This document is crucial because it contains commercial property's net operating income (NOI). This information is necessary to calculate income projections and return-on-investment (ROI).
What is the development plan for this area?
Investors buy commercial property for one reason: to make profits. Therefore, it is essential to be aware of all future and current development projects that may impact a building's profitability.
What happens if you buy a property intending to run it as a spa and then find out that a new airport is being constructed just a few miles away? You won't see much relaxation. This means you won't make a lot of profit.
Moral of the story: Ask around to see if there are any commercial building permits in the area.
What are the zoning ordinances in place?
After deciding on the location, zoning laws are the most critical aspect of commercial real estate investments. A city or county sets zoning ordinances that define the use of a commercial property. These ordinances should be aligned with investor plans.
It is not good to buy a property to start a retail store, only to discover it is zoned for office buildings. Successful investors will apply for variances or re-zonings, but it is not always guaranteed.
Is there a sustained demand for commercial property?
Sustainable demand is quite different from demand.
Commercial real estate is best if you target a specific population for tenancy. This makes it easy to assess demand. For example, student housing is very under-supplied. This means that demand will continue to be high for many years.
This is an essential aspect of any development. A high level of demand will ensure that your investment stays attractive over the long term. This can preserve yields, make it easy to exit and increase capital growth potential.
Are property guarantees a good idea?
A commercial real estate investor should confirm that the guaranteed income period for the property is valid. Compare the guarantees to other properties in the area, especially rental demand. Evaluate the need for such property in a particular location.
Can I trust the developer?
The property's potential profit potential may be limited, regardless of how great a location is. Many new developers are attracted to commercial real estate because of the high yields. These developers should be avoided.
It would be best to look at past developments in the same industry. This will allow you to determine their track record and performance.
What exit strategy is in place?
Flexible exit strategies are a vital element of any commercial real estate investment. While the attractiveness of your investment property is an essential factor, it's also crucial to consider the investment terms you agree to.
The best conditions for a flexible exit strategy are long guaranteed income periods with attractive yields. Investors have the option to exit at any time during the investment cycle, while buyers can enjoy attractive terms on fully operational and proven developments. A healthy capital growth rate of up to 40% can be achieved, with the initial high yields indicating a lower investment level than market value. This is often the case for new builds. This flexibility is not possible in shorter periods of guaranteed income due to lower investment terms available at resale.
Guaranteed buy-backs are another common investment condition. These can provide some flexibility, but they should be carefully examined before investing in commercial real estate. Guaranteed buy-backs should be based upon a proven business model, not just projections.
Is it compatible with my investment objectives?
Two crucial elements of security that many investors neglect are:
- How well does an investment fit their objectives?
- Will it be a great addition to their portfolio?
One investor might find it is an excellent investment, while another investor may not be interested. Remember that diversification is essential and commercial properties are a great way to do this without spending a fortune.
What are the risks of commercial real estate investment?
Mitigating risk is a critical component of any successful investment. Commercial property is no different. Another option is to make sure contracts are solid and asset-backed.
Developers often set up shell companies that provide guarantees through third parties. Unfortunately, these companies are often without assets and can be very insecure.
It's always a good idea not to think about the worst-case scenario. Instead, consider the potential impact on your portfolio and yourself and what you can do to prevent it.
Should you Invest in Commercial Property
Asking the above questions can help you determine if an investment is safe, profitable, and suitable. It is essential to ask professionals questions, no matter how silly they seem. Your understanding is the most crucial aspect of any investment's security, even if you have to ask a hundred more questions.
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