Building a Business or Portfolio through Commercial Real Estate
Just like homebuyers look for a house that fits their lifestyle, budget and future plans, small businesses and investors need to strike the right balance and consider the future when buying commercial real estate (CRE).
Depending on the property and how it will be used, the traditional real estate considerations of location, appeal, condition and upkeep need to be considered. Buyers also will need the support of a specialized team that understands the ins and outs of CRE, said Ben Loesel, Assistant Vice President of Business Banking at Twin Cities-based North American Banking Company.
“You want to work with a banker who really understands your business and what you’re trying to achieve,” says Loesel. “You want to work with a knowledgeable commercial inspector or contactor who can identify any issues with the building. In addition, you want to work with an experienced commercial broker to help with tenant negotiations, and to ensure you get the best possible purchase price.”
In short, buyers of commercial real estate – especially first-time buyers – should view it as a team effort and assemble their team with care.
Investment vs. Owner Occupied
Most commercial real estate transactions fall into two categories: Buildings that are owned as an investment, and those that are owner-occupied and used for conducting business.
Within these categories there are a lot of variables. Investment properties might be single tenant, multi-tenant, or residential. Owner-occupied buildings might be retail stores, restaurants, industrial buildings or warehouses.
Each type of real estate has its own fundamentals, which can affect the size and terms of a loan – location matters less for industrial buildings, while amenities matter more for office or retail space.
“You really want to do your due diligence and have an environmental report prepared,” Loesel says. “Sometimes an industrial property previously had hazardous material stored on site or has an abandoned tank buried on the property. If you find out about these after you buy, and there is a problem, suddenly you’re spending tens of thousands of dollars to remediate the property to current environmental standards.”
Bankers with commercial real estate experience understand these variables and can help businesses and investors figure out if buying makes sense. “You have to make sure the property is going to generate enough cash flow,” says Loesel. “If you’re only clearing $400 a month, you won’t be able to save up enough for repairs that inevitably happen.”
Leasing carries its own challenges. Loesel says in the best case, buyers should get tenants signed to long-term leases, and sign a guarantee on the lease. “You don’t want to get stuck without a tenant,” he says.
The Importance of Relationships
One long-time real estate investor who works with North American Banking Company stressed the value of building relationships. “The bank has to be pretty comfortable with you,” he said.
A bank like North American Banking Company, which knows the local market and gets to know borrowers personally, is an asset for investing, the investor said. “They offer great service. I’d rather be a bigger borrower with a smaller bank than a small borrower in a giant bank.”
By building trust over time, investors can create trust so that banks are willing to step up quickly when opportunities appear. “A lot of transactions you might want to make happen sooner than later,” the investor noted.
Relationships also matter in terms of running the properties. “You want to have a good property manager,” the investor advised. His portfolio includes many single-tenant commercial buildings and some townhomes. Since he can’t personally serve all those tenants, bringing on good people to handle the day-to-day work is critical.
For buyers who do their homework and are willing to wait for the right opportunity, Loesel sees commercial real estate as a solid investment in the Twin Cities. “The overall commercial real estate market in the Twin Cities has been strong for 5+ years. However, you don’t want to get over-excited and lose sight of the fundamentals,” he stressed. “It pays to be patient.”
Commercial Real Estate Tips and Considerations
- Understand Down Payment and Financing: If you’re new to commercial real estate, know that the terms of CRE loans will be different than those used in residential transactions. Expect to have a down payment of at least 20-30% of the purchase price and a fixed 5-year interest rate, although actual terms and rates can vary.
- Look Closely at Age and Condition: If a building is aged or may need significant work, banks may be less willing to loan as much up front. However, if the plan is to rehab the property, those improvements can be financed along with the building’s purchase. Transactions of a certain size will also require an environmental inspection.
- Plan for Tenants and Upkeep: For leased buildings, it’s best to have tenants lined up and locked into leases, ideally for 5 years or more. Whether leased out or owner-occupied, a good rule of thumb is to budget at least 5% of your gross income annually for repairs and maintenance.
- Be patient: First-time buyers can sometimes lose sight of the fundamentals: location, property condition and good tenants. Advice from experienced partners or mentors can help you wait for the right opportunity.