As we approach Halloween, it’s the perfect time to delve into the spooky world of CRE investing. Plenty of consumer protection laws are available when you buy a house, but buyers should beware of the frightening mistakes that can haunt your commercial real estate portfolio and spook your returns.
In this article we will unearth seven scary CRE investing mistakes to avoid at all costs. Whether you’re a seasoned investor or just starting, these bone-chilling blunders can send shivers down your spine.
Mistake 1: Neglecting Proper Due Diligence
Purchasing a commercial property without extensive due diligence is like stepping into a haunted house blindfolded. By neglecting this vital step, you open yourself to a world of horrors, including unforeseen maintenance issues, legal complications, and hidden liabilities.
As an investor, you want to identify and catch significant property issues, such as HVAC (heating, ventilation, and air conditioning), electrical and plumbing, fire sprinklers, roof, and overall building structure. If repairs are required, get quotes for the cost, then return to the negotiating table with the seller.
It’s also important to understand that there’s more to inspecting commercial real estate than might first meet the eye. Areas where some buyers skimp on inspections include:
- Title defects and survey concerns such as mortgages, liens, judgments and assessments against the property, pending lawsuits, probate issues, easements, and encroachments.
- Verifying zoning and land use to ensure that you and your current and future tenants can use the property as intended.
- Code enforcement liens, expired permits, pending development and easement obligations, and unpaid water, electric, sewer, and gas bills all create potential legal liabilities once you close on the property.
- Hazardous waste and environmental concerns, such as an old underground storage tank, can lead to millions of dollars in clean-up costs, even if you or the previous owner didn’t cause them.
Before closing any deal, thoroughly investigate the property’s financials, legal documentation, and physical condition. Engage the expertise of inspectors, appraisers, and attorneys to ensure you’re not walking into a nightmarish investment.
Mistake 2: Buying in a Bad Location
We’ve all heard that real estate is about location, location, location. But the problem is what makes an area good or bad can be pretty subjective, just like your favorite Halloween candy.
Important location factors to consider to make unbiased investment decisions include:
- Neighborhood and submarket demographics
- Traffic patterns and ease of ingress and egress
- Amenities on-site and nearby
- Available space for tenant expansion
- Proximity to where people live, work, and play
- Safety and security of the location, especially on evenings and weekends
Mistake 3: Misjudging Investment Potential
Even when you buy in the best location available, misjudging investment potential is still possible.
One trick to watch out for is a seller who won’t allow you enough time to plan your investment properly. To make an informed decision on a potential investment, consider issues such as:
- Rental rates, potential growth, and replacement costs
- Competition from nearby properties, including projects planned and under construction
- Growth rate needed to justify increased occupancy and rising rents
Mistake 4: Acting as Your Own Broker
In a market where every dollar may count, some buyers try to cut corners and avoid paying out any commissions by acting as their own real estate brokers.
Even for sophisticated commercial property investors, there are plenty of good reasons to consider the fees and real estate commissions of hiring a seasoned broker as a cost of doing business:
- Avoid significant potential pitfalls that can delay closing or create a breach of contract.
- Real estate brokers have expertise in specific asset classes such as office, retail, multifamily, industrial property, and land.
- Sales agents can refer you to leasing brokers, property management companies, lenders, and contractors to help maximize the value of your real estate investment.
- Brokers work on real estate deals all the time, so they know the nuances and customs of the local market.
Mistake 5: Failing to Diversify Your Portfolio
Just as you wouldn’t go trick-or-treating with a single piece of candy, you shouldn’t limit your CRE investments to a single property or asset class.
Most people understand the importance of diversifying IRAs by holding different types of stocks and bonds, spreading your risk so that assets will balance one another depending on to the market’s overall direction. Yet a surprising number of real estate investors put all their eggs in one basket, rather than diversifying to reduce risk.
Consider investing in different types of property, locations, and investment strategies to spread risk and maximize potential returns. By building a diversified portfolio, you can enjoy a treat of stable income while avoiding putting all your money into a single sector that may face unexpected headwinds.
Strategies you can use to diversify your real estate investment portfolio include:
- Diversify by asset class, by owning different types of properties.
- Diversify by geography, by investing in different parts of the country.
- Participate in a partnership investment, if purchasing an entire property on your own isn’t feasible.
- Minimize the risk of higher taxes, by researching opportunity zone investments.
Mistake 6: Using a Boilerplate Purchase Contract
A standard purchase contract may be fine if you buy a house listed on your local MLS, but not when investing in commercial real estate. Each transaction is unique and complex, and much higher stakes are involved.
Typical pitfalls you can avoid by using a customized commercial real estate purchase contract include:
- Using the right type of real estate deed to maximize the seller’s obligations and the buyer’s rights.
- Understanding how seemingly minor details such as estoppel certificates, subordination, nondisturbance, and attornment agreements can delay the entire deal.
- Creating an exit strategy that allows you to exit the transaction penalty-free, just in case you realize the investment requires more capital or expertise than you currently possess.
- Memorialize critical details within the contract using specific contingency clauses because courts only consider what’s in the commercial real estate contract if you need to settle a dispute.
Mistake 7: Succumbing to Emotional Decision-Making
Investing decisions driven by fear or greed can be terrifyingly detrimental to your portfolio. Getting caught up in the heat of the deal is another CRE investing mistake you want to avoid, especially if you’re negotiating with a seller who knows your hot buttons.
Instead, approach CRE investing with a rational mindset based on thorough analysis and research. Stick to your investment strategy, and don’t let market fluctuations or emotional roller coasters dictate your decisions. Deciding what, when, and where to buy should only be influenced by strategic considerations such as location, property size and asset class, historical financial performance, and a reasonable balance between risk and reward.
One daunting mistake many real estate investors make is overlooking upfront and ongoing costs associated with the property. These include past-due rent collections, fixing deferred maintenance that the seller still needs to finish, and forgetting about the cost of TIs (tenant improvements) when you’re turning over vacant space.
Emotions can cloud your judgment and lead to impulsive, ill-advised investment choices.By overcoming emotional traps, you can avoid investment nightmares and stay on the path to long-term success.
The Bottom Line
In today’s real estate market, trying to save money in the short term can cost you a lot more in the long run. As we journey through Halloween, remember to avoid these seven scary CRE investing mistakes. By avoiding these pitfalls, you’ll increase the odds of making a profitable investment, providing solid cash flow year after year.