Buyer’s Guide
In the right circumstances, purchasing commercial property can be a wise investment. Commercial real estate includes any property that you use to grow, expand, or support your business. Owning commercial property gives you a chance to build equity, make your expenses more predictable, and possibly gain tax advantages.
Why You Should Invest in Commercial Property
The small business sector in America occupies 30-50% of all commercial space – an estimated 20 billion to 34 billion square feet. Owning your own property is a sound investment for your business that has multiple benefits.
- Fixed Rates – When you own the property there is no risk of market rent increases. With a fixed-rate loan, you’ll know what your month-to-month costs are.
- Tax Breaks – The costs involved in owning and running your business space can result in favorable capital gains treatment and expense deductions like property taxes, mortgage interest, and more.
- Total Control – The property is yours, meaning you can do with it what you like. Renovate, paint, and knock down as many walls as you want.
- Public Exposure – Establish the personality and culture of your business. Maintaining, customizing, and improving the quality of your property helps represent your business and promotes strength and stability.
Questions to Ask Yourself
Before you begin searching for commercial property, ask yourself some questions. The following will help you better understand your business goals, needs, wants, and type of property you should be looking for.
- What does the property need to be zoned for (office space, restaurant, retail, etc.)?
- Will you be using the building for your own business, renting it out, building equity, or another use?
- Where do you want the property located?
- Do you need to buy, or could you lease?
- How much of a down payment can you afford?
- Would you be willing to partner with someone else on the property?
- What’s your risk tolerance?
- How much time can you commit to the property?
- How much work are you willing to put into the property?
- Will you need a property manager?
- Are you willing to do the duties of a landlord?
- Are you ready to make a purchase of this size?
Before buying a property it’s important to make sure the decision is right for your business long-term. Think carefully about what could happen in the first 12 to 24 months after buying a building that could make you think “I made a mistake.” If you overestimate the amount of space you need or revenue you’ll have, you may experience some problems.
Common Commercial Real Estate Terms
After answering the above questions and determining that buying a commercial property is the right choice, you should become familiar with some commercial real estate terms. It will make the process of working with others easier.
- Loan-To-Value (LTV) – A ratio of how much money you’re asking from a lender vs. the total value of what you want to purchase.
- Debt Service Coverage Ratio (DSC) – Operating income over total debt service. How much of the debt you’ll be able to cover each year with income?
- Capitalization Rate (Cap Rate) – Income of the property divided by the total value of the property.
- Cash on Cash – Annual income over how much you actually invested. The amount invested could be just the amount your down payment was.
- Vacancy Rate – Percentage of properties that are vacant in a time period in a given area.
- Usable vs. Rentable Square Feet – Rentable square footage is the usable square footage plus a portion of the building’s shared space. Usable square footage is the area you will use to conduct business on a daily basis.
- Ad Valorem – A tax based on the assessed value of a piece of property.
- Price per Square Foot – A calculation of the value of each square foot of area of a building. It is a simple, but useful calculation that is mostly used to compare similar properties.
- Building Class – Commercial buildings can be class A, B, or C. Building classifications denote what kind of condition a commercial property is in, with Class A buildings being the best.
Identifying the Right Property
There are a number of factors to consider when looking for commercial real estate to purchase. In addition to the number one factor, location, remember to consider the following while searching for property.
- Location – You should evaluate your customer and target demographic and research where they’re located and where they shop. If you’re a storefront you want to be located in a place that is convenient for your customers. If you’re operating an office or warehouse you should pick a location that is close to your employees and vendors.
- Physical Condition – How does the property look? Will it require a new coat of paint and some touch-ups or more extensive upgrades? If it’s an older building it should also be tested for asbestos and lead paint.
- Allowable Uses – If you’re operating an ad agency or tax firm, you’re going to need commercial office space. A warehouse is going to need an industrial space. It’s important to be aware of zoning laws and what you can and cannot do on the property.
- Limitations to Possible Modifications – Zoning laws and building codes can limit what changes and alterations you’re allowed to make to both the exterior and interior. Buildings deemed historic will have extensive protection on them to preserve their appearance and significance.
- Access and Parking – You need to ensure there is enough parking based on estimated foot traffic. Access also needs to be compliant with the Americans With Disabilities Act.
- Opportunities for Expansion or Leasing – If your business grows will you have room to expand? In addition, if you’re business doesn’t grow as you had predicted will you be able to lease the extra space?
Work with Experts
It may be tempting to handle the purchase of commercial property on your own, however industry experts can offer invaluable skills and knowledge.
- Broker – Your broker will be aware of market trends, can search for properties that fit your needs and wants for you, and has access to listings that you may not.
- Accountant – An Accountant’s role is to help you figure out what you can afford to spend on a property, analyze the tax implications, and help you budget for the purchase.
- Lender or Mortgage Broker – Your lender or mortgage broker can help you understand and make decisions about the most affordable and cost-effective bank loans, SBA loans, and other available financing options.
- Lawyer – A lawyer will negotiate with sellers and lenders on your behalf and ensure you complete the transaction in accordance with relevant laws. A good lawyer will also make sure you understand how the contracts and agreements you sign will affect your business.