Commercial Real Estate Investment – Basics

Commercial real estate investment is the natural progression from residential property investment. Experienced property investors tend to move into commercial real estate sooner than later – and for very good reasons.

Once your portfolio grows you will find it very difficult to manage your investments if a large portion of them is tied in residential properties. Imagine if you have $15 million worth of residential properties. That will be a lot of homes and tenants to take care of.

On the other hand $15 million will buy only a very small number of commercial properties that will be comparatively easy to manage with much lesser overheads.

Commercial properties include offices, industrial sheds, free standing retail shop, bulk retail, block of shops, medical centers, service stations, motels, hotels, back packers, health clubs, churches, funeral parlors, child care centers, car yards, convenience stores, shopping malls, to name just a few. Each type of commercial real estate investment has its own peculiarities, strengths, problems, rewards and risks.

The return on investment in commercial real estate is much higher than residential property.The income is net and not gross because the tenant pays all the out going expenses. The income is also more stable because of the long leases.

It is typical to have returns of around 10% net for a commercial real estate investment and any where from 7% to 9% net return for a prime property.

The value of a commercial real estate to a great extent is determined by the quality of the lease. In general the value is determined by taking net contractual rental being paid and use of a capitalization rate to arrive at a value. The value is also determined by the quality of the tenant and length of the lease.

The value of a commercial property can drop substantially if it becomes vacant. I have seen commercial properties being sold at less than half their value if they are difficult to lease.

Commercial property management is also much simpler because tenants have a strong vested interest to maintain the property to a high standard. Tenants usually derive their income from the property. They have to keep the property looking good and maintain functionality to impress their clients.

I have seen tenants spend hundreds of thousands of dollars to make improvements to the property. Most of these improvements stay with the property long after the tenant has left the property.

Real estate law is more flexible towards commercial lease contracts. You can virtually word and add any clause that is agreeable to the contracted parties. It is common to charge penalty interest on the out standing rent or lock the premises on continued default of rent.

By far the biggest risk in commercial real estate investment is finding a new tenant in case of a vacancy. In commercial real estate the requirement of each tenant in terms of size, location, use and rent payment capacity is so different that it is very difficult to get the right tenant for the right property.

For the reasons mentioned above it is also difficult to sell a commercial property investment. Higher the value of property there are lesser number of investors to buy the property. A commercial property investment is less liquid than other investments because there are very few players in the market. For a residential house there will be hundreds of potential buyers which is not the case with commercial properties.

Commercial real estate investments are generally sold on capitalization rates and rarely on replacement value. It is therefore possible to purchase a poorly rented commercial property well below its market value. You can also increase the value of your commercial real estate simply by raising the rents during rent reviews or re-negotiating the lease terms when it come up for renewal.

The funding for commercial property investments is harder to get as banks look at the quality of tenants, length and terms of lease. They will typically fund a maximum of 50 % to 66% of the market value of the property. The lending rates are also marginally higher. You will therefore need more equity to buy. This reduces your leveraging power to buy more property.

Commercial real estate is where professional investors put their energy because of the higher returns and ease of managing them. For these investors commercial property is their ‘bread and butter’ and they drive their speculative income by trading in residential properties.

Some commercial investors focus their attention to improve and add value to their commercial portfolio. Whilst others use their rental returns to fund development projects that show much higher returns but need different and more advanced skill sets.

Commercial property investing is very rewarding but requires more knowledge, experience and capital out lay. It is advisable not to jump into commercial real estate from the very out set until and unless you have the knowledge, very deep pockets and risk taking ability. It is advisable to start with residential real estate investment to build your equity and cash flow.

You should buy at least 8 to 10 residential investment properties before venturing into the world of commercial real estate.

Prospecting For Commercial Real Estate Listings

When you prospect in commercial real estate sales or leasing situations, you will meet with and will talk to many people on a daily basis. The more people you do this with the better. Prospecting is critical to your business growth and listing processes in any market.

It is interesting to consider what prospecting situation you find yourself most often in. The answer is different for everyone as each person has communication preferences and methods of approach that works for them over other standard approaches. It is therefore most important to prospect in the way that suits your character and business style.

Your daily prospecting method should be the thing that works for you and gives you the best results and could be any or all of:

  • Telephone
  • Door to door
  • Networking events
  • Referrals
  • Face to face contact

In all respects the prospecting and meeting process will be enhanced if you refine it and use a small number of statements that gain the attention of the prospect. We call these statements ‘Prospect Value Statements’ (PVS) and they must relate to you and your commercial or investment real estate market.

Prospect Value Statements

The ‘Prospect Value Statement’ is one of a kind and should match you, your business, and your focus. It should clearly declare and communicate the fundamental reason why your organisation exists and why you’re selling or leasing commercial investment property from the prospects perspective. It is the most important thing that you can learn and use in commercial real estate. That being said, it is amazing how many salespeople in commercial real estate do not master the concept and some never even know about it. The PVS is such an important statement to your conversion process that we will spend time now on it in helping you design your own.

So why is the PVS so important? It succinctly, clearly, and precisely defines what you do and how you do it in commercial real estate. Better still, it does so in a way that your clients and prospects can see and know why they should do business with you. The PVS will tell them that you are better than the competition agents in the market.

The PVS plays a role in just about every business opportunity and prospecting situation that you come across.

Sample of a Commercial PVS

‘We assist our commercial investor clients in the industrial market at Salisbury to find new tenants that match their investment plan or cash flow expectations, and therefore enjoy a more stable occupancy. We do this by canvassing all tenant changes in the region for the coming 3 years and directing deals to the desirable tenants at the right time for our clients.’

Sample Structure of a PVS

‘We assist our commercial clients (companies, tenants, or investors) in the … industry (or business, or market segment, or location) to … and enjoy … We do this by …’

To make this work, it’s important for you to know and really understand what end result benefit you actually deliver to your commercial real estate prospects, customers and clients (be they landlords, tenants or investors). You also need to know exactly what benefit your prospects or clients actually want to gain, enjoy, achieve, or have in this market. Your PVS is matched to the end user of your services at all times.

‘Your PVS will also change over time as it will have relevance to the current market conditions and the pressures that your prospects need resolved.’

So What Results and Benefits do Prospects Need?

Before you start to create a PVS or a series of them for you and your business, let’s define some of the results and benefits that are typical desired outcomes for a client or prospect in a commercial real estate sale or lease situation. Consider your market. What are the priorities of the prospects that you deal with today?

Commercial Real Estate Lease situations:

  • Stable tenant
  • Good rent
  • Long lease
  • Major tenants
  • Quality tenants
  • Ability to refurbish
  • Make good obligations
  • Growth of rent
  • Stability of rent
  • Sound lease document
  • Resolving vacancies faster

Commercial Real Estate Sales situations:

  • Quick sale
  • Higher price
  • Confidential sale
  • Method of sale
  • Faster settlement
  • Good enquiry
  • Good promotion and marketing
  • Comprehensive market coverage
  • Sale to investors
  • Sale to owner occupiers

Given these benefits and your market trends now in your location, you should be able to easily construct a series of PVS models that suit the prospects that you deal with. Ideally you should be able to quickly call on 2 or 3 of these statements in any prospecting conversation to match the needs or interest of the prospect you are talking to.

How a Commercial Real Estate Broker Can Help You

Commercial real estate is a booming business; however, whether you are buying or selling commercial real estate, chances are that you are going to need a bit of help. A good real estate broker can be invaluable to you, and they can provide you with a great deal of help that no one else could ever give to you. If you want to have a successful career in the commercial real estate business, then more than likely you will need to work with a commercial real estate broker from time to time. The following are some of the great ways that a commercial real estate broker can be of help to you.

Local Land Values

Having a commercial real estate broker working with you can be very helpful when it comes to local land values. As an investor, you may not always be investing in commercial real estate that is in your area, and it can be hard to find out what the land values are in the area that you are considering investing in. When you work with a commercial real estate agent, they usually have a good grasp on local land values and can help you make good decisions based upon this information. This saves you having to do a great deal of research on your own to find out the same information.

Access to City Officials

If you have been working in the commercial real estate field long, you know that there are many times in this line of work when you have to deal with various city officials. At times this can be difficult, since you may not be familiar with them and you may have a hard time finding time to speak with them. When you work with a commercial real estate broker, many times you will find that they already have direct access to the city officials, which can expedite your deals much of the time.

Negotiation and Constructing Offers

Another great reason to have a commercial real estate broker is that they can do a great deal of the negotiating for you on a deal. It is usually better to have a broker as a go-between instead of dealing directly with the other person in a deal. A broker can usually more effectively negotiate the terms of a deal. They can also help you to construct offers as well so that you will be able to present a good offer on a piece of commercial property.

Exit Strategies

More than likely there will be some point in time when you will find it imperative that you get out of a commercial real estate deal. This can be hard to do on your own, but when you have a commercial real estate broker to help you, then can help you to come up with a solid exit strategy if you need it. When you get out of a deal, you need to have a great strategy that is totally legal, or you may end up losing a great deal of money. Having the commercial real estate broker there to help you can ensure that you exit the deal in a legal way that will not hurt you as well.

Referrals to Other Professionals

Commercial real estate brokers can also be of help to you by referring you to other professionals that can be helpful to you as well. This is especially great if you are new to the commercial real estate industry, you have just moved into a new area, or you are investing outside of the area when you live. It can be difficult to find good professionals to work with, such as lawyers, contractors, inspectors, and engineers. When you are dealing with a commercial real estate agent that you trust, they can refer you to other people that you can trust as well. This saves you the hassle of trying to find some of these professionals on your own without anyone’s recommendations to go on, which can be disastrous in some cases.

Lenders

Another area that a commercial real estate broker can help you with is the financing for your commercial real estate purchase. These broker work with a variety of different lenders from day to day, and if you are looking for financing for your venture, more than likely they can steer you in the right direction. They may even know of some private lenders that may be of some help to you as well.

First Grab at Targeted Properties

Having a commercial real estate broker can be very beneficial to you because they can also allow you to have first grab at some targeted properties that they know of. No doubt there are times when you find a great property, only to find out that it is already under contract and you spoke too late. If the broker knows what you are looking for, they may be able to pocket the listing so you can have the first chance at it.

When you do find a great commercial real estate broker, it is important that you hold onto them. A great broker can be invaluable and can help you out in a variety of ways that will help make you successful in the commercial real estate market. Working together with the same great broker over and over can be mutually beneficial to both of you. They will get the rewards of your business, and you will be able to enjoy the many benefits of working with an excellent commercial real estate broker that you can trust. When you find a good broker, they are definitely worth the money that you will pay out to use them.