When it comes to commercial real estate investing, investors often want to know what types of properties they should consider investing in. This article is about 5 groups of properties and the reasons why you should or should not consider them.
1.Earth: People who invest in virgin land often expect to buy farmland near commercially zoned land for a few thousand dollars per acre. They dream that their lot will be rezoned as commercial in the near future, which is worth hundreds of thousands of dollars or more per acre. People who convince you to invest in virgin land are often trying to sell you on this dream. While this dream actually happens as if it is possible to hit the jackpot in Las Vegas, the reality is that most investors lose money or get little return on their land investment. It is a very risky investment as the land generates little or no income. From an income tax standpoint, the value of the land does not depreciate, so you cannot claim depreciation. In addition to that, the interest rate on the land loan is also very high compared to other types of commercial properties. Therefore, each month, you would need to get money to pay the mortgage without charging anything. You should consider investing in land if
– Know how to develop in order to convert vacant land into a shopping center.
– Know exactly what you are doing and have a deep pocket.
– Own the land of a shopping center (you do not own the buildings).
2. Apartments: this is an intensive management investment as the turnover rate is high. Leases are short term often one year month to month. As tenants move in and out, you will need to spend money to prepare the unit for occupancy. Apartment renters tend to have a higher history of late payments than other renters, as they tend to be on a tighter budget. If you don’t like the headaches of dealing with lots of tenants, you probably want to stay away from apartments. The key to a successful apartment investment is
– Control or minimize expenses. This may seem like a trivial task until you see the list of expenses provided by the property manager. These expenses include: advertising, accounting, bank fees (for non-sufficient funds), capital improvements, money laundering allowance, cleaning, collection fees, garbage removal, insurance, landscaping, legal fees (eviction), maintenance, administration of off-site property, on-site property management, pest control, painting, repairs, sweeping, security, property, utilities and water.
– Invest only in properties in a good location without deferred maintenance.
– Stay away from rent controlled areas eg Berkeley, Los Angeles.
Otherwise, you may end up with little cash flow or even negative cash flow. If high cash flow is one of your investment goals, you may want to stay away from apartments. In California, if you own an apartment with 16 or more units, you must have a manager on site. This further increases expenses. In general, apartments are easy to buy and more difficult to sell. There are always plenty of them in any market. The advantage of apartments is that they tend to have a high occupancy rate, as everyone needs a roof over their heads. Because of this fact, the interest rate on apartments is typically ¼ to ½ percent lower than other commercial properties.
3.Special purpose properties: These are properties designed for a specific business, for example, restaurants, gas stations, and hotels/motels.
– Restaurants: Some investors like to invest in brand name fast food restaurants like Burger King, Pizza Hut, Jack In The Box, KFC. These are single-tenant properties with a long-term absolute triple net lease that often do not require management responsibilities on the part of the owner. However, the rental income or cap rate for these restaurants is typically lower, in the 5-7% range. Emerging regional branded restaurants like Johnny Carino’s, Back Yard Burger, Zaxby’s or Tia’s TexMex tend to offer a higher cap rate in the 7-8.5% range. However, when you look deeper into the financial statements, they still may not be making a profit. Restaurant operators sell the real estate to investors with a higher capitalization rate and lease the property for 20 years. In turn, they use the proceeds from the sale to expand their business by building more restaurants. So if you are willing to take higher risks, you will be rewarded with high income with these pop-up restaurants.
– Gas Stations: When you buy a gas station, you buy both the property and the gas station business. Most gas stations also have convenience stores and sometimes multiple auto repair shops. Gasoline markup is set at 10-20 cents per gallon [many customers wrongly blame the high gas prices on the innocent gas station operators] but it is quite high for a convenience store. This is considered an owner-occupied property that qualifies you for an SBA loan with as little as a 10% down payment. If you are not planning to get involved in running gas station, car repair and convenience store business, you may want to stay away from gas stations as gasoline is a chemical that could pollute the soil. Once a leak occurs and pollutes the environment, it takes years and a lot of money to clean up the ground. You may even be liable for damages to adjacent property owners, as the contamination may spread to their properties. It is almost impossible to sell your property as no lender wants to lend buyers the money to buy it.
– Hotels/Motels: once you buy a hotel/motel, you buy real estate and a business 24 hours a day, 365 days a year. This business requires hard work and marketing skills to fill the halls. The rooms are worth nothing if they are empty. Business tends to be seasonal and can be immediately affected by economic downturns and political events, for example 9/11. Many of these properties are owned by Indians with the surname Patel, as they seem to work the hardest and know the business well.
4. Office buildings: These properties are single or multi-story buildings. Older two-story walk-up office buildings tend to have trouble finding tenants on the top floor, as many service businesses may have clients with physical disabilities who are unable to climb stairs.
– Single-tenant buildings: The properties are used as corporate headquarters for large corporations such as Cisco. These large buildings tend to be more sensitive to the economy. Once vacant, it is difficult to find a replacement tenant.
– Multi-tenant buildings: These properties are rented by small businesses, eg real estate, tax accountants. Investors who buy these properties want to spread the investment risks. When a tenant vacates a unit, he only loses a small percentage of the rental income.
– High-quality tenants: Most of them have good credit, many assets, and pay their rent on time when it is due.
– Leases: Office building leases range from full service [landlords pay property tax, insurance, maintenance and utilities] to NNN [tenants pay property tax, insurance, maintenance and utilities]. The NNN lease is a litmus test as to whether the office building is in high demand from tenants or not.
– Medical buildings: These properties are leased primarily by doctors and dentists. A good medical building should be across the street from a hospital. This makes it convenient for doctors to go back and forth between the hospital and their offices. Some investors prefer medical buildings as medical tenants are very recession resistant.
5. Shopping Centers/Retailers: These centers are mostly single story and can accommodate a wide variety of tenants: retail and service businesses, restaurants, doctors, schools, and even churches. As a result, this is the most popular type of commercial property sought after by investors. They are always in high demand as there are more buyers and fewer sellers.
– Multi-tenant strip: the advantage of this investment is that when a tenant moves, they only lose a part of the total income while looking for a new tenant. So you spread the risks on this property.
– Single tenant building: The advantage is that you only have to work with one tenant. Some of the tenants — Costco, Home Deport, Walmart, CVS Pharmacy, for example — sign a 10- to 20-year lease and guarantee their corporate assets that could be worth billions of dollars. This makes your investment very secure.
– High-quality tenants: Most of them have good credit, many assets, and pay their rent on time when it is due. They often sign long-term leases from 5 to 30 years so you don’t have to worry about finding new tenants every year. They keep their property in good condition and sometimes even spend their own money to make it look better in order to attract customers to the stores.
– Triple Net Leases (NNN): the leases of shopping centers are usually in favor of the lessor. Tenants pay a base rent and reimburse the landlord for property taxes, insurance, maintenance, and sometimes even property management fees. This takes a lot of risk off you as an investor. The NNN lease, in a sense, is a litmus test as to whether or not the property is in high demand by tenants.
– Land Leasing: Occasionally a shopping center is sold with a land lease. When you buy this hub, you only own the improvement, but not the land underneath. It could be a trophy property, but you should think twice before investing. Once the land lease expires and the landlord refuses to extend it, you own nothing! So it is easy to buy this center but very difficult to sell.