There are plenty of consumer protection laws available when you buy a house. However, buyers should beware when it comes to commercial real estate because the same laws simply don’t apply.
Here are some common missteps to watch out for in a commercial real estate transaction to ensure you don’t get tricked into buying someone else’s problem.
1. Buying in a Bad Location
We’ve all heard that real estate is all about location, location, location. But the problem is that 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
2. Misjudging Investment Potential
Even when you buy in the best location available, it’s still possible to misjudge investment potential.
One trick to watch out for is a seller who won’t allow enough time to plan 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
3. Being Emotional
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 what your hot buttons are.
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 that 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 hasn’t finished, and forgetting about the cost of TIs (tenant improvements) when you’re turning over vacant space.
4. Using a Boilerplate Purchase Contract
Using a standard purchase contract may be fine if you’re buying a house listed on your local MLS, but not when you’re investing in commercial real estate. Each transaction is unique and complex, and there are much higher stakes 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 by using specific contingency clauses because courts only consider what’s in the commercial real estate contract if you need to settle a dispute.
5. Skimping on the Inspections
As an investor, you want to identify and catch major 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 of repairs, 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. Scary 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 – creating 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.
6. Acting as Your Own Broker
Experienced real estate investors know that money is made when property is purchased, not when it’s sold, which is one reason why having immediate equity is so important. Some buyers try to cut corners by acting as their own real estate brokers.
However, even for sophisticated commercial property investors, there are plenty of good reasons to consider professional 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.
7. Not Diversifying
Most people understand the importance of diversifying their IRAs by holding different types of stocks and bonds, with assets that correlate differently to the market’s overall direction. However, a surprising number of real estate investors put all of their eggs in one basket instead of diversifying to reduce risk.
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.
In today’s real estate market, trying to save money in the short term can end up costing you a lot more in the long run. By keeping an eye out for these scary CRE investing mistakes, you’ll increase the odds of making a profitable investment that will provide solid cash flow year after year.