Commercial Real Estate can be a fantastic investment because of the capability to have reliable, passive returns as well as the potential for upside in the commercial property purchased. This article considers that you are investing passively in a deal. If you are a real estate investor looking to be an active manager of commercial real estate, that is a different conversation. Of course, you’ll be told the general information on the deal like the purchase price, property manager, interest rate on the debt (if you’re not, run the other way!), but before investing passively in a commercial real estate deal, here are five things you should know before you move forward.
- Know your operator. There are several different great operators in this space. I have a co-worker who says “people don’t invest in businesses, people invest in people”, and I couldn’t agree more. You need to understand who the team is behind this investment property. Be ready with questions for the managing principals. How many deals have they gone round trip with? What is their communication pattern with their investors? How long have the principals been real estate investing? Who will be on the property management team? What is the expected cap rate (capitalization rate) at purchase and what the target IRR (internal rate of return) for the entire project? Will there be cash flow from day one? If not, what is the investment strategy to raise the net operating income that will make this a profitable investment? When does an investor receive K-1 forms? Will there be triple-net leases? What LTV (loan to value ratio) are we targeting at refinancing? Do the managing partners invest in their own deals? What are their fees? Make sure you do your due diligence on who is going to be handling your hard-earned cash before you allocate funds.
- No two deals are the same. We have all heard the (mildly annoying) term, “past performance is not indicative of future results”, but it is something to consider when looking at a deal. Yes, the firm you are investing with should have a great track record, and if you are working with a top tier firm, they likely know how to pick a deal that they can underwrite confidently and execute the plan for that investment. That said, if you are investing in a single deal with any operator, make sure you are picking apart the deal so you completely understand what the asset is and the plan in place to make it successful.
- Know your market. The same way no two deals are the same, no two real estate markets are the same. Make sure you are clear of the market dynamics and trends for the property that is being purchased. Commercial real estate investors need to stay mindful that this is not residential real estate. Commercial building standards and commercial tenants will vary by market. What are the property taxes in the market the asset is located in? The commercial investment property asset class is the type of property that will need additional considerations by the property owners? They’ll need to be aware of the growth potential of the local economy, the average income of the population in that area, and the path of progress. we’re not suggesting that you don’t need to consider that when investing in residential real estate, but residential can be a bit more forgiving if you don’t get it right.
- Know your asset type. Two residential properties right next to each other will likely perform the same, but an office building next to an apartment building or a mixed-use retail space may have completely different outcomes. Vacancy rates for office space might be sky high in that surrounding area. Maybe there are maintenance costs or operating expenses specific to that rental property that will make this a less desirable investment opportunity. Understand which type of commercial real estate investment is being purchased (office, industrial, multifamily, or retail) and research other real estate properties like that in the surrounding area. Various assets will come with different levels of risk. You will want to understand the supply and demand in the area for that property type (or businesses inside of that asset) as a point of consideration prior to investing funds.
- Time. Everything will almost always take longer than anticipated. Especially in larger projects. If you have vetted your operator and the deal that is being purchased, be patient with it, as you have already done your part to the best of your ability. The rest is on the operator at this point. There may be factors that are out of the operator’s control that may extend timelines and delay return expectations. Although everyone tries to do the most thorough due diligence they can, problems can and will happen. If they do, make sure that your operator is being fully transparent and communicative with you about what has happened and what updated plan is from that point on.
In commercial real estate investing, you can do extremely well with passive investment in the right deal as many wealthy investors have done in the past and continue to do. Use the 5 considerations above as guardrails when reviewing a deal. If you are currently reviewing a deal and you’re concerned it may be one to avoid, check out this article for the signs you should avoid a private CRE deal. If you have any questions regarding anything in the commercial real estate world, please don’t hesitate to reach out to someone on the team here at First National realty Partners. This is what we do all day long.
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