Commercial real estate is touted as a high-yielding passive income. However, like most wealth-making opportunities, success isn’t a given and requires research, structure, strategy, and proper execution. In short, a lot of work and investment must be put in before any “passive” money flows back your way.
Successful commercial real estate deal formulas begin with research and developing a plan that includes mapping out investment goals. Base potential income on current data, not just projections. Ensure you can still profit while meeting obligations when working out other investors’ cuts.
Commercial real estate isn’t like buying a house. The flashiest, most high-end properties are not necessarily the ones that will help you reach your goals. Finding the best deals requires an evaluation process that sifts through the opportunities and reveals the gems that meet your needs and anybody else in your investment team.
How To Structure A Commercial Real Estate Deal
Before plunging into a deal, it’s essential to understand commercial real estate basics. Learn as much as you can by reading articles, listening to experts, and talking to those you respect who are already familiar with the trade. Research how commercial property is valued, how leases in this sector typically work, and understand the financing options.
The more knowledge you obtain, the better equipped you are to draw up realistic goals and work through a successful commercial real estate deal.
Find Your Team For Your Commercial Real Estate Deal
Your plan of action for a commercial real estate deal should begin with deciding who is on your team.
If you are new to the sector, have a mentor with experience on your side to help you avoid pitfalls.
Also, be sure any people brought on board have the same goals and outlook. Having some members expecting a short flip while others are seeking a long-term investment creates friction and can undermine a deal before it has begun.
Lastly, an excellent real estate attorney is essential to help ensure all contracts are compliant. You’ll also want advice and options to help protect personal assets from your new investment opportunity.
Consider Your Financing Options
Commercial real estate deals can be financed in a number of ways, and which method you and your team select will impact:
- Your budget
- How much exposure is given to your personal assets and credit rating
Popular methods of funding are:
- All-cash: Pay in full by yourself or your investment team
- Traditional bank loan: Like with a home, there is often a down payment percentage
- Hard money bank loan: The bank gives a loan based on the property’s value, not your credit
- Seller financing: A financing deal is made directly with the seller without the bank
When working on a financial plan with others, it’s essential to ensure that you can still put money away for yourself while giving all other parties their due.
Have Clear Property Goals
Ensure you and your team have clear goals on the types of properties you want to target. Are you looking for office, retail, industrial, or multifamily?
Be clear on the parameters. For instance, are you keeping it local? While property managers are great, you might prefer to be able to still be able to check in from time to time without needing to make travel plans.
Location also has a big impact on demand. Some areas have too much flashy office space but still have a high need in the industrial, like workshops, storage, or warehouses.
Also, take the temperature of local laws, regulations, and zoning laws.
Create Your Real Estate Deal Structure
Whether you are buying in with your buddy or a team, there needs to be an agreement on everyone’s role. Are certain people just bringing in the money? Who is doing the grunt work? These questions can be answered while creating a deal structure.
The main four points of the deal structure will be established:
- Who manages the property: Are you hiring a property manager? If so, who checks on them?
- Where does the cash flow: As the cash comes in, how will it be allocated, and how will earnings be divided between all invested parties?
- Who oversees the loans: Somebody needs to be the main overseer of the repayments, whether to the bank, seller, or private party.
- Who assesses financial performance: Members must agree on the person or organization to do the job, and the dates reports will be made available to all invested parties.
Establish Property Assessing Metrics
Commercial real estate is full of metrics to determine if a property is worthy of an investment. Ensure you and your team know which metrics matter to your deal and how to calculate them accurately.
Consider:
- Net Operating Income (NOI): First-year gross income subtracted by operating expenses.
- Capitalization Rate (Cap Rate): Property’s NOI compared to market value
- Gross Rent Multiplier (GRM): How many years will it take to earn the purchase price?
Take The Calculator And Walking Shoes With You To Viewings
No property is too good to walk away from. The moment you can’t walk is when the deal just became more expensive. You’ll get the better price if you are willing to stick to the numbers, look for flaws, and always (always) keep punching in the numbers to ensure the property can meet the needs of your financial goals.
In addition, the calculations should always be made at current and past markets, not future hopes. If there is a forecast of a downturn, be wary. But don’t be seduced by future promises. That favorable change of zoning laws on the horizon might happen but don’t bet your wealth on it. Instead, check that the property can bring in enough if the good news never materializes.
Lastly, motivated sellers are always a gem. But no matter how willing they are to hand it over, the property must still meet your plan’s metrics. So, while seeking out the motivated seller is the best way to get the price you need, don’t let the “deal” blind you to red flags.
Research And Build Local Relationships
Research should never cease until the deal is done. Explore the area, introduce yourself to local businesses, pop into open houses, and view other properties in the market. Read the local paper or social media page to take the local temperature and learn details that might not be easily gleaned from reports. Think of it as due diligence before reaching the due diligence phase.
Conclusion
The promise of passive income from commercial real estate only comes to those who invest in developing and implementing a structure. However, following a real estate deal formula with sound structure and purpose will reduce wasted time, money, and opportunities while raising the rewards.