If you are buying commercial property …
November 8, 2013
Commercial properties are typically purchased for two primary purposes: investment and business use.
If you are thinking of purchasing commercial property primarily for investment, you will want to consider the following:
Are you an active or a passive investor? — If you have appropriate time, energy and skills, a fixer-upper or "add-value" property could be ideal. These properties are typically much less expensive on a comparable unit cost basis due to the investor assuming greater risk, which can result in much higher returns (or losses!).
How will the property be managed? — A professional property manager will typically charge 4-5 percent of the property's gross income for their services. If the property has numerous tenants, gross leases requiring landlord maintenance or is located far from where you reside, you may want to account for professional management services in your financial analysis of the property. If, however, the property is nearby, smaller in scale, with only a few tenants or has net leases, then you may choose to avoid professional management in an effort to increase your financial return.
What is your risk tolerance? — Greater return carries greater risk. A well-located retail property occupied by a strong national tenant might provide an overall return in today's market of around 5-6 percent. In comparison, a multi-tenant strip retail center with local "mom and pop" tenants might provide a return of around 10-11 percent. The latter investment is much riskier as local retailers have a higher failure rate than national chains. Is the greater return worth the risk? A lot may depend on other contributing factors such as location, visibility, building age, quality of construction, traffic counts and market area.
What type of commercial property is best? — I believe there is no correct answer to this question, as each type has its own pluses and minuses.
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Retail properties are used for displaying and selling goods and services to the public. They include street retail (think downtown Grass Valley), freestanding (South Auburn Street), strip centers (The Home Center), pads (Starbucks), larger neighborhood centers (Raleys), or special use properties (gas stations, etc.).
Retail leases are typically triple net (NNN), meaning that in addition to base rent, tenants pay their proportionate share of operating expenses for the property. Landlords often prefer NNN leases as they can help maintain a consistent rate of return over the lease term. Some retail leases have percentage rent clauses, allowing rent to increase over a minimum rent based on a percentage of gross sales generated at the location. Visibility, location, access and parking are critical retail property components.
Office properties include medical, professional, R&D/Flex and administrative/back office. Multi-tenant office buildings are very common and provide a diversified and balanced income stream (in the event one tenant vacates, there remains income from other tenants to help cover fixed expenses).
Office leases can be net or gross, often guided by the norms of the particular geographic market in which they are located. Gross leases require that an investor budget for certain operating expenses and maintenance not covered by the tenants. Other vital factors to consider when investing in office space are building efficiency, design flexibility and quality of rent roll (number and type of tenants, length of tenancies, scheduled rental escalations, renewal options and tenant payment histories).
Industrial properties house manufacturing, distribution or warehousing operations. Power supply, loading docks, bay size, truck doors and ceiling heights are integral to the desirability and value of industrial buildings. A market analysis identifying the types of building features in demand in a particular market is very important prior to any purchase.
Multi-family properties are residential buildings containing five or more living units. Types include senior housing (with different levels of care including independent, assisted and convalescent), federal and state subsidized low-income units and market rate apartments.
With numerous residential tenants, good property management is key to a well-performing building. An on-site manager is specifically required by law for apartment buildings containing 16 or more units. Demographics and demand should be carefully examined prior to investing in apartments. Top commercial real estate brokers can provide you with apartment market studies to enable accurate occupancy and income projections.
This article only touches the surface of what to consider when purchasing commercial or investment property and working with experienced professional consultants is highly recommended.
Sperry Van Ness – Highland Commercial has just released its new Q3 2013 "Commercial Property Review" quarterly newsletter full of specific details and the latest economic trends in the Nevada County commercial real estate market. This newsletter is now available at http://www.svnhighland.com or by calling Lock Richards at 530-470-1740.
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