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6 Tips for Investing in Commercial Real Estate

Written by Posted On Wednesday, 13 February 2019 17:20
Scott Callahan of Orlando, Winter Park, FL Scott Callahan of Orlando, Winter Park, FL

This article is designed to create a step by step process for investing in commercial real estate.  

1.  Identify Your Goals.

This seems like a simple question, but it can be a little more complicated than you think.  Everyone wants the real estate that they own to appreciate in value.  But that alone isn’t the end of the analysis.  And the better you understand your goals, the less likely you are to make a mistake.  For example, what is your risk profile: extremely aggressive or really conservative.  Most investors lie somewhere in between those extremes.  Another factor to consider is what is the duration of the investment your looking to make, short term or long term?   And do you need this investment to generate income or not?  Once you identify your goals, then you can start to focus on what to buy.

2.  Where and What Type of Real Estate to Invest in. 

Although real estate is generally considered its own asset class, there are different types of real estate to consider as you narrow your search for the right one.  Do you want to own raw land for example, and if so where?   Or do you want to own a fully leased office building, and again where?  In some respects, it is generally good advice to buy what you know, which means real estate in your geographic region; but if your level of sophistication is high, your geographic considerations may be wider.  And you may be more familiar with certain types of real estate than others.  Retail v. industrial for example.  If you have an expertise, stick with that (i.e. multi-family, industrial, retail, etc.).  Keep in mind that your analysis should focus on how best to meet your investment goals.  Once you pick an area to invest in, and the type of real estate you want to own,  the hard work really begins.

3.   Research, Research, Research. 

Once you identify the location and type of real estate you want to invest in, you have to roll up your sleeves to find the specific property you want to buy.  And although you may have identified the general area you want to buy in, you now have to determine what submarket is the right location  (i.e. core business district, urban, suburban, rural)  and  has the most potential.  This is where a knowledgeable commercial real estate agent who is familiar with your geographic focus can help.  With their expertise, you can identify hot sub-markets and those that aren’t; areas that are more expensive and mature versus those that are up and coming.  With their help you can also learn about pricing and what fits your budget and what doesn’t.  This exercise will further narrow the choices so that you can identify a few different properties that meet your investment requirements.  With that information, you can start to formulate an offer to purchase the property.    

4.   Starting the Buying Process.

Once you identify the property that you want to buy and the price you want to offer, it’s time to put together a letter of intent (an LOI) to submit to the current owner.  An LOI contains the general terms of the purchase such as price, initial deposit, additional deposit, any due diligence period, financing contingency, closing date and other significant terms.   It’s not a contract and therefore isn’t enforceable like one.  Because it is very basic and isn’t enforceable buyers and sellers like to use these before going to the expense of putting a contract together to make sure that there is a general agreement about the transaction.  Once there is, it makes sense to incur the expense of drafting a contract.  If there isn’t an agreement, everyone has saved a bunch of time and money. 

A broker can help you put that together or you or your attorney can do that.  The things that are most often negotiated in these LOIs besides the purchase price are deposit amounts and the length of your due diligence period.  Pay attention to these items to make sure that you can meet the financial and investigative requirements that those provisions contemplate.  The due diligence period can be an especially tricky item, so make sure you know what you need to do and how long that will take in order determine that the property is suitable for you to purchase on these terms.   For example, if you can’t fully understand the condition of the property within the due diligence period, you either have to negotiate an extension of the due diligence period or terminate the contract.  Otherwise, you will potentially lose your deposit if you don’t close.  So getting the timing of that correct is important. 

  1. Drafting the Contract.

Once the LOI is signed by the Buyer and the Seller, its time to draft the purchase and sale agreement (PSA).   It’s wise to have an experienced real estate attorney involved in this process, either drafting it or reviewing it.  While the LOI is the outline of the business terms, there are lots of details that the PSA needs to include and if you’re not careful here, a mistake can be expensive.  So it is important to pay a lot of attention to the details of the transaction in order to avoid those mistakes.  One way to go about this process is to review the general form of a PSA and identify the sections that you are the most concerned about, and there will be more than one.  Examples will be the purchase price and deposit sections.  When will your deposit become non-refundable?  The inspection period section is also important.  What does the Seller have to deliver to you and by when (i.e. permits, leases, etc)?  Can you extend it if you don’t get that information or if you find out there is an issue with the property?  Closing date issues are also important.  Is it a date certain or does it take place only after you have fully examined the property and its condition?  If not, can you extend the closing date?  Remember that this entire process can be expensive, legal fees, inspection fees, etc., so you will want to have as much control of and flexibility with this process.  Those are a few examples, but there will be more.  Meet with your attorney and have them go over the issues in each section you are concerned about and draft the contract to address those concerns. 

Once that is done, the PSA is sent to the Seller and the negotiations commence.  This process can take either a short or long period of time.  Set expectations based on the time frame you need to meet.  If you don’t have a signed contract within that time period, then it may be time to move on to another property.  If you are able to get the PSA signed, then the process begins and its time to get to work making sure that the property is in the condition that you need it to be in for you to make your investment and purchase the property.

  1. Starting Your Due Diligence.

Now its time for your attorney and other experts to go to work.  Hire people who are experienced in buying real estate of this type.  If you’re not going to manage the property yourself, get your property manager involved in this now too; although they probably should already be involved to help you identify the property that they think meets your investment goals.  This list is extensive, so you or someone else will need to quarterback the process.  You need someone to look at the title to the property and understand what limitations there are on operating it; zoning and land use issues too.  All required permits should be issued before you buy this, so make sure that is reviewed.  What is the physical condition of the property?  How expensive will any repairs be?  Is that contemplated in the price you agreed to, or do you need to renegotiate the price?  How about financing.  Who will make a loan on the property?  Make sure that they are up and running right away too.  Your lender will also need some time to perform their due diligence, appraisals, title review, etc.   If the property is leased, make sure the leases are in the form and duration that work for you.  All of these items are crucial and must be thoroughly examined before you can finish your due diligence and be comfortable allowing your deposit (and any additional deposit you are required to make) become non-refundable. 

These basic tips I have provided should help you get started in your venture, but please don’t stop here. There’s plenty more to learn about commercial real estate investment through local government. National organizations like the National Association of Realtors, Commercial and the NAIOP, the Commercial Real Estate Development Association can provide you with a wealth of information and tips that could be invaluable to you.

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Scott Callahan is the Managing Partner of Salerno Capital Partners, an opportunistic investment firm focused on providing capital to businesses throughout the U.S. He is a dedicated philanthropist in the Orlando and Central Florida community, and oversees the Callahan Family Foundation. Click to read Scott's monthly blog.

 

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Scott Callahan

Scott Callahan is the Managing Partner of Salerno Capital Partners, an opportunistic real estate investment firm focused on providing capital to businesses throughout the U.S. He brings decades of expertise into the commercial real estate investing field, as a former real estate attorney. He is a dedicated philanthropist in the Orlando and central Florida community, and oversees the Callahan Family Foundation

scottcallahanorlando.com

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