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Buying or renting? Such is the question many business people ask themselves around the 1st of the month — right before writing their business’ monthly rent check. With the interests rates being what they are and prices being affected by the commercial paper crisis, the answer might very well be yes to buying if the right property becomes available and you can afford the cash down.
Owning commercial real estate can have it’s advantages.
- Choices: As the owner, you can decide whether to select a building that matches your current needs, has enough room for future expansion or maybe is large enough for you to lease out other parts of it.
- Equity: Every month, your payments are applied to paying down your mortgage and building some equity, which could be useful eventually to secure a loan for new equipment, to finance an acquisition or simply as an asset.
- Appreciation: Not withstanding any unforeseen occurrences, your building should appreciate with time. This appreciation could, just as the above mentioned equity, be used to get better financing conditions.
- Power: As the landlord, you are the person in charge of deciding how to finance the building, pick tenants, choose the decorations and amenities, selecting entrepreneurs for the work to be done, improving the building. You even have control over your monthly rental rate.
So, if it’s so great, why doesn’t everyone do it?
The main reason why many business owners don’t own the commercial space they’re using is that there’s always the concern of what happens if you hit a business slump and can’t make the mortgage payment. It takes years to make a business profitable, let along generate enough excess cash flow to invest in commercial property. Yes, it is possible to buy commercial real estate with no money down, but you still have the responsibility of paying the mortgage each month. If your cash flow doesn’t allow you the flexibility should things slow down in your business, then you may not want to reconsider the risk.
Your business’ cash flow’s growth stage.
If your business is bringing you a comfortable and predictable income, you may want to consider investing your profit to leverage further growth. On the other hand, would spending an important part of your income hinder any growth possibility for the near future? In either case, you need to have a firm understanding of your business financials and historic cash flow before making a step to acquire the property.
Having adequate reserves
Usually, the purchase of a commercial property requires a 20% cash down which, in some cases, can end up being a lot of money. Also, don’t forget you also have to factor in the price of insurances, taxes, legal fees, building repairs and maintenance and an allowance for vacancies. Due to the importance of the figures involved in assessing most commercial real estate transactions, you should surround yourself with adequate representation meaning: a good commercial real estate broker with experience and a positive track record as well as solid financial and legal advisers.
Examining the tax perspective.
In addition, you should meet with a competent financial adviser or a CPA who knows your specific personal and business finances and could best evaluate and advise you in regard to your particular financial situation. For now, keep in mind that, in most situations, you will be able to use some of your expenses and depreciation to reduce your taxes. In addition, you’ll be able to count the rent as a personal income.
You make your money when you buy, not when you sell.
One last but extremely important factor to consider before making your decision is that you make your money when you buy but realize it when you sell.
In other words, paying more than the fair market value, not taking into consideration your cash flow factors (mortgage, interest rates, insurance, taxes and repairs VS incoming rent, other income possibilities such as parking, for example, or letting your feelings dictate a purchasing decision may negatively affect your exit strategy for years to come if you are not careful.
Though appreciation is quite probable, we suggest you don’t factor that in when crunching your numbers. If the deal is still a good deal, without factoring in appreciation, you are likely to make a favorable ROI (return on investment) when you decide it’s time to sell for your exit strategy.
If you absolutely need appreciation to justify your purchase, be extremely careful as no one really knows what will happen in the future and, in the present, you may be paying too much.
Discuss the situation with your commercial real estate broker and other advisers either way before you invest.
What you should remember.
So we looked briefly at the different aspects of buying a commercial property. Remember the advantages of being a landlord are:
- Choices
- Equity
- Appreciation
- Power
In addition, make sure:
- You thoroughly analyze, run and re-run the numbers so you fully understand the risks
- You carefully evaluate, understand and allow for your future cash flow.
- Purchasing the property won’t hinder your growth strategy.
- You can afford additional expenses, as well as unexpected and sometimes quite expensive repairs and maintenance.
- You can afford the cash down.
- You get advice from a professional financial adviser about your tax situation.
- You get advice from legal council.
- You get advice from a professional real estate adviser.
- You void free advice as it often end up being the most expensive kind.
Owning a commercial property can be an excellent investment if you do your homework and fully understand the risks.
Bill Manassero is the founder/top dog at “The Old Dawg’s REI Network,” a real estate investing blog, newsletter and podcast for seniors and retirees. His personal real estate investing goal, which is being chronicled at olddawgsreinetwork.com, is to own/control 1,000 units/doors in 6 years. Prior to real estate, Bill and his family lived in Port-au-Prince, Haiti as missionaries, serving orphaned, abandoned and at risk children for their nonprofit organization Child Hope International.
