When you read those lists of the “wealthiest people in the world,” you should notice a pattern: most of them are involved in commercial real estate. Investing in real estate provides some of the highest returns.
“If you don’t know your numbers, you don’t know your business,” says Marcus Lemonis, self-made millionaire CEO of Camping World, host of The Profit, and serial entrepreneur. This quotation applies to all aspects of life, including real estate due diligence.
Here’s a high-level overview of the commercial real estate purchasing process: a single-tenant net lease building or a regional shopping center.
1. Determine the Opportunity
First and foremost, before purchasing the first commercial property, you see, conduct extensive research, stay current on industry news, and even collaborate with a commercial real estate broker. Spend adequate time assembling the right team (broker, lender, financial analyst, legal, etc.)
Then, decide on your specific investment criteria and timing. Is this, for example, a 1031 Exchange for tax deferral? If so, ensure the purchaser checks all required boxes within the time frame. Reduce your list of potential properties by conducting market research on each.
2. Submit to Underwriting
This stage entails conducting an in-depth financial analysis using current data (including occupancy, rental income stream, taxes, and utilities) and future performance assumptions. Also, unless you are a cash buyer, you will need an equity source and debt or loan. Determine whether you can obtain the necessary capital to purchase the property.
IMPORTANT ANSWERS TO FIND:
- Why is the property being sold?
- Should your strategy be more aggressive or conservative based on current market conditions?
- What are the current rents for tenants? Can they be raised?
- What is your expected return on investment?
- Can expenses be cut?
- What is your exit strategy?
3. Submit the Letter of Intent
The Real Estate Purchase Letter of Intent is the first formal action that a seller and a buyer take. It addresses significant points of interest/concern negotiated over a set period, culminating in the final Purchase and Sale Agreement. You’ll benefit if you’re familiar with essential terms such as cap rate, NOI, ROI, debt coverage ratio, lease types, etc.
Here are some less standard but crucial lease terms to understand before purchasing a multi-tenant property.
4. Conduct Complete Due Diligence
The ultimate goal of this time-limited period during the commercial property buying process is to reveal the rights, boundary lines, accepted future uses, development options, and more. Due diligence will also reveal known and unknown issues with the title, surveys, easements, encumbrances, liens, or restrictions that may affect the property’s use or development. Examples of restrictions include licensing requirements, environmental concerns, zoning restrictions, and legal compliance.
Interviewing the current tenants is a critical step in this stage that should not be overlooked. For example, suppose a tenant had a plumbing problem a month ago, and the existing owner (seller) was unresponsive. In that case, the problem will eventually become your responsibility when you close and become the landlord.
5. Pre-Close
It is when most prospective buyers are removed from the seller’s picks due to bid price, inability to execute, or buyers withdrawing. The last few prospects are told to make their best and final offers.
The “winning” buyer then submits the PSA or the contract created between the buyer and the seller, which acknowledges all relevant information about the property being exchanged and each party’s rights, obligations, and liabilities.
6. Close
When the final stage of the acquisition process is reached, an escrow agent is hired to hold deposits and any other funds in a third-party account until both parties have met all preconditions in the escrow agreement.
Commercial escrows are much more complex and formal than home closings. It is common for capital to come from multiple sources. Commercial transactions are subject to fewer regulations than residential transactions, including the absence of the Real Estate Settlement Procedures Act (RESPA), and the paperwork is more customized.
As previously stated, this is only the foundation for a successful commercial property purchase. Even if it is not your first time, the process is always more complicated, so keep these details and tips in mind.
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Come join us! Email me at mark@dolphinpi.us to find out more about our next real estate investment.