Purchasing Office Properties
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The Commercial Office Market
The office sector’s fitful recovery has begun to stabilize, with improvements reaching more metros. Net absorption for the past few quarters has been reminiscent of leasing activity in 2007, and the take-down of space by long dormant office tenants suggests stronger momentum on the horizon.
Over the past 12 months, vacancy rates in most markets tightened significantly, lowering the national office vacancy rate by 50 basis points to around 16.5 percent as of the first of this year. Net absorption has approached 17.9 million square feet, a 41 percent increase over one year ago. Another key driver in performance improvement has been the lack of new construction. However, lender and investor belief in the sustainability of the U.S. economic recovery, as well as more capital sources entering the arena, has resulted in a significant ramp-up in new supply in select gateway metros.
People start out investing in residential real estate simply because they’re more accustomed to buying homes, but commercial real estate can be a great way to balance your portfolio. You just need to bone up on the different rules and terms in the commercial market. So get ready for a primer on buying commercial properties.
Residential Vs. Commercial
Following are the differences between commercial and residential real estate investments.
• Commercial real estate is valued differently. The income that a piece of commercial real estate produces is directly related to its usable square footage. This isn’t always the case with residential.
• Commercial property helps diversify risk. For example, if you own an apartment building and you lose one of your 10 tenants, you only lose one-tenth of the income for that property, instead of the entire rent as you would if you lost a tenant in a single-family house.
• Cash flow is often greater with commercial real estate. The yield is often higher per square foot and on an initial investment basis than it is in residential. If you lease or rent a multi-unit commercial property, you have more tenants to generate income than you do with a single-family dwelling.
• Commercial real estate leases are generally much longer. This helps with the stability of your cash flow.
• Commercial property is valued by the bank differently. You’ll need to find a bank that works with commercial real estate (most major lenders do), and it’ll want a higher down payment than for residential property—usually 30 percent or more.
Now, here’s one similarity:
A common mistake people make is thinking that commercial real estate doesn’t go into foreclosure. It does. Many of the same rules that Bill Nazur and I wrote about in our book Finding Foreclosures apply to commercial real estate as well. Banks don’t want to own commercial property any more than they do residential, and you can find the properties using the same methods as residential units.
Doing Your Homework
As with any investment, it pays to do your homework. Find out what the vacancy rates were with the previous owners. Talk to storefront managers and find out what they like—and don’t—about doing business there.
Are they planning to renew their leases?
What did they like about former management? Is business booming?
Are any residential properties being built in the area? Is the site properly zoned?
Are companies like Lowe’s and Home Depot moving in—a sign that there may be more demand for storefronts in the area?
Is the population’s median income at least at the national average, and are people maintaining their income levels?
How are the current store owners doing financially? Have they been behind on rent before?
Be sure to ask to see the sellers’ cash flow statements, too.
Once you take the time to understand the ins and outs of commercial real estate investing, it can be extremely rewarding both financially and personally. So, what are you waiting for? Start rounding out that portfolio.