Editor's Note: Learn from a panel of experts and entrepreneurs who have successfully financed their own ventures and are helping others do it at the Thought Leaders Live 2013 event May 29, in Long Beach, Calif. Event and ticket information can be found here.
In my previous article, I talked about buying residential foreclosures. In the final installment of my series, I'm focusing on buying commercial real estate. Many 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.
Danielle Babb is an experienced real estate investor and specialist on the use of technology and real estate. She is also the co-author, with mortgage broker and realtor Bill Nazur, of Finding Foreclosures: An Insider's Guide to Cashing In on This Hidden Market, available at Entrepreneur Press.